Introduction - There are two types of inflation, "fiat inflation" which is from increasing the money money supply and "credit inflation" which is from increasing the availability of credit/debt throughout the financial system.  Usually there is a mixture of money supply growth/contraction and credit growth/contraction.  The inflation of the late 1970's, when gold hit $800 per ounce, was largely "fiat inflation." The recent inflation is largely a "credit bubble" or "credit inflation."  Also, in the current inflation we believe that essentially any money supply growth, although also fairly large, has been mopped up by the increases in productivity, provided first by the personal computer revolution and next by the internet revolution and technology.  Without increases in credit/debt nor increases in the money supply, we believe we would have already seen a substantial drop in the prices of goods and services due to the increase in productivity.  We believe we did not see that substantial drop in prices (yet) because of the increase in credit/debt, i.e. "credit inflation."  However, as we have detailed below, there have still been pockets of deflation and price drops and, we believe, when "credit inflation" turns into a "credit contraction" or "credit bust," we will experience the overall deflation that was postponed.  Unfortunately, a credit contraction most likely means prices of risky assets, which went sky high on the way up, will likely drop precipitously on the way down.

       Importantly, historically, fiat inflations have achieved "soft landings;" however, credit inflations are most likely to have "hard landings" because much of the credit/debt goes into default and usually takes years & years to work out.  Remember Japan's credit inflation topped out in 1989/1990 and they are still suffering its effects 18 years later!

      Accordingly, we think monitoring and considering the affects of deflation on asset values could save informed investors from future heartache; thus we started this Deflation Watch Weblog.  Also, see our Elements of Market Tops and Major Trend Change Indicators weblogs and our Annual Forecasts for commentary and analysis more specific to those topics.

THE WATCH STARTS NOW

(June 18, 2004 - in reverse Chronological Order)

August 22, 2007, WSJ.COM, "Anxious Home Builders Pile on the Incentives;" we would add "to get buyers to buy,"  We are using this article to confirm the decline in housing prices as we have correctly forecast throughout these pages.  This article gives several examples of builders cutting prices of between 10% and 20% and/or offering incentives of the same relative size.   "...real-estate agents are going to new extremes to attract buyers, dangling lavish incentives and slashing prices."  Including:

Boca Raton, FL - offering to pay two years of property taxes and insurance

Richmond, VA - up to $100,000 off the cost of upgrades

Medford, OR - offering four months rent, and will still negotiate a lower price

"Across the country, the theme is the same: Homebuilders and home sellers are juicing their efforts to unload single-family homes.  Among other things, they are offering buyers cash discounts of as much as 20%, throwing in a pool and agreeing to finish basements, garages and other spaces at a cost of several hundred thousand dollars..."

San Diego, CA - "...clients are scoring multiple concessions totaling as much as $80,000 [on houses in the $700,000 range].  Generally, that includes a price reduction, an agreement to pay closing costs or upgraded flooring or appliances -- or a combination of all three." 

Dallas, TX - price reductions as much as 20% and free swimming pools.

A well known analysts says "This trend toward more-generous incentives is likely to intensify....citing a growing inventory of new homes, an oversupply of pre-owned homes on the market and a glut of homes that are a year or two old that investors bought as rental property that have never been lived in, and those investors are now trying to sell, too."  We at Stamper Capital find it ironic that back as far as 2004 people just rolled their eyes when we said there was no shortage of homes.

Tallahassee, FL - "builders are offering incentives and price markdowns of as much as 15%..."

Bensalem, PA - "has knocked nearly $200,000 off the price of some already built million-dollar homes...and is offering an additional $20,000 reduction for buyers who buy inventory homes before Labor Day."

Website www.homebuilder.com apparently has "...the most comprehensive listings for new construction homes."

Of course, we find these price reductions and the incentives to buy a reflection of the deflation that is accelerating.

August 14, 2007, BLOOMBERG, "Subprime-Infested Funds Drive Demand for [U.S.] Dollars;"  "The [U.S.] dollar is no longer the currency you love to hate.  Now, it's the currency you can't live without."  "Last week's credit crunch has set off a worldwide RUSH for dollars as banks and fund managers scramble to pay back loans used to buy risky mortgage securities."    Well, this certainly is a Major Trend Change (that we have forecasted - see our Major Trend Change Indicators weblog) - however, we would have titled the article: Huge U.S. Dollar Short Covering Rally to Ensue.

We want to make a few points about what is going on:

     1).  A huge U.S. Dollar short covering seems to be in process as borrowers of U.S. Dollar denominated debt are rushing to pay it off.

     2).  To get the U.S. Dollars to pay off loans, U.S. dollars are going up in value.

     3).  With U.S. Dollars going up, almost everything else will be dropping in price - other currencies, industrial commodities, financial commodities, gold, stocks, real estate. - Deflation (ugh).

     4).  Loans being paid down is a "credit contraction."

     5).  The demand for U.S. capital is likely an upward force on U.S. interest rates.  As reported below, worldwide, central banks infused a record amount of liquidity into market to bring back down short term interest rates, which had spiked up unexpectedly, related to this credit contraction. 

Yes, the U.S. Dollar is a "safe-haven currency" but we believe this is more of a credit-contraction-and-U.S.-Dollar-denominated-debt short covering rally than a flight to the U.S. Dollar safe-haven currency rally.  However, we expect this trend to last a number of months or even over a year and to be pretty much in parallel with deflation and a drop in the prices of risky assets.

August 10, 2007, BUSINESS WEEK (August 20 & 27 edition), "Where Home Prices Drop, Malaise Follows;"  We are using this article to validate our previous forecast that the decline in the real estate market would "ripple."  Talking about declines in home sales volumes, "state sales tax figures, a proxy for spending, are much weaker in the hardest-hit states."  "A drop in sales of homebuilding materials and equipment is a factor.  But Florida retail sales figures show a BROAD PULLBACK, with falling auto and durable goods sales and a sharp slowdown in consumer nondurables such as clothing.  Its hard to explain this trend if you don't believe that the housing bust has any impact on spending...."  We note that now most analysts are agreeing with us that the housing downturn is spreading to other sectors.

August 10, 2007, BLOOMBERG, "Countrywide, Washington Mutual Fall on Mortgage Slump;"  We are using this article to confirm "deflation" in the prices of homes.  "We are experiencing home Price Depreciation almost like never before, with the exception of the Great Depression," said a CEO of a major home financier.  Quite a statement from the top person at a major home lender.

August 10, 2007, CHRON.COM, "Commodities Fall for Second Straight Day;"  "Commodities prices came under pressure on Friday as fears of a credit squeeze led to more selling on Wall Street and spread to the energy, industrial and agriculture markets.  It was the second straight day that most commodities were pummeled by the overall uncertainty in financial markets.  Many analysts continue to back a view [we do not] that strong global economic growth, particularly in China and other fast-growing nations, and strained supply of raw materials paint a bullish picture for commodities prices in the longer term. BUT this week, investors have grown increasingly anxious that deteriorating credit conditions in the mortgage market, which sent stocks lower, could become viral and have reduced their exposure to risk." 

We have been somewhat dumbfounded that analysts could have been thinking that way.  To us, when you have a credit contraction, financing dries up; and when financing dries up, prices that were financed with high levels of debt can no longer be maintained.  To us, it is pretty simple math: lower the amount of financing available from the current (or what was just current) record levels of debt and prices of just about everything are going to drop.  In addition, to us, it has been fairly easy to see a significant downturn on the horizon.  How could analysts think commodity prices would be going up with the economy and thus demand dropping -add declining levels of financing (from record levels) and you have a recipe for precipitous drops in prices of end products - and their components (i.e. commodities) especially after the consumer has been gorging like crazy over the past several years, financing the majority of their purchases with declining savings (to below zero per year) and with hair raising levels of debt.

August 1, 2007, CBS MARKETWATCH, "Gold Falls, Together with Global Stocks;"  "Gold futures fell Wednesday, weighed down by a global rise in risk aversion sparked by renewed credit market concerns that sent international stocks tumbling."  "Bullion has failed to benefit from safe haven trades and has followed equities lower as worries about spreading credit problems prompt investors to flee from riskier assets..."    Whoa!!! gold going down in reaction to risk-aversion.  Gold bugs and inflationists wouldn't expect that.  However, to us, this (gold dropping along with stocks, other risky assets, and, in conjunction, with a "flight to safety") is more proof that what we are facing is deflation - caused by record debt levels (that financed the stock and housing bubbles) contracting.

Please see our Elements of Market Tops weblog for a listing of articles signaling and confirming the onset of the credit contraction we have previously forecast.

July 19, 2007, BLOOMBERG, "Miami Condo Glut Pushes Florida's Economy to Brink of Recession;"  We will use this article to highlight that real estate has fallen previously by very large amount.  What is interesting to us is that no one seemed to remember that until recently.  "In the 1970's, when condos were a new product, Florida developers built 500,000 units and prices fell 50%," a researcher in this article said.  Continuing, "the difference is, back then they were two-story condo buildings that had $50,000 units; nowadays they are $700,000 units in 20-story buildings.  Instead of building too much stuff that people could afford like we did then, this time we built too much stuff that people can't afford."  Interestingly, speaking about the continued building after real estate has turned down, one real estate broker is quoted, "This is dumbfounding to me; it's a building boom in the middle of a housing bust."  That is interesting.  It is likely related to the fact that builder likely feel they will lose more money if they stop before completion and they are hoping for a positive turnaround.

July 10, 2007, BLOOMBERG, "Sears, Home Depot Say Profit Will Fall on U.S. Housing Slump;"  That is a good headline - we are calling it the "Big Ripple is Just Starting."  In the article an analysts says, "We're seeing the effects of the housing market ripple through the consumer segment."  "The biggest U.S. housing slump in 16 years has reduced spending on big-ticket items, causing appliance sales to decline."  Home Depot said " [its] sales may decline for the first time ever." Note that Sear's stock price dropped approximately 9.5% on the day.  It is amazing to us that just a few months ago, most analysts were saying there would be no ripple due to the downturn in housing - have been warning about this for some time and believe this is only the beginning of the ripple's negative effects.

July 10, 2007, CNN/MONEY, "Mortgage Resets: Record Bill Coming Due - Billions in Subprime ARMS will be subject to higher payments;"  Another article on the sub-prime adjustable rate mortgage Trigger that is essentially here.  "More than two million subprime adjustable rate mortgages (ARMs) are poised to reset at much higher rates in coming months, worsening an already suffering housing market."  "In October alone more than $50 billion ARMs will reset."  Analysts in the article estimate that a typical monthly payment will go up by about 39%.  As we forecast a couple of years ago, we believe this situation will most likely result in mortgage defaults and push the prices of houses downward (as the banks unload them) - not only that but those who continue to make the higher payments will have less money to spend on other goods and services, lessening their demand and likely resulting in dropping prices.  Loan defaults will continue to the credit contraction that we documented recently started when credit standards were raised.  We believe these multiple ripples will result in sales and revenues of less essential businesses and of luxury businesses dropping, causing defaults across the economy.  At this point, you can probably see how the debt cycle that has been essentially expanding since 1980-1982 has now begun to contract and will do so in a similar self-reinforcing cycle (but in the opposite direction).  All of this is thoroughly documented throughout this risk-adjusted website.

June 30, 2007, MONTEREY COUNTY HERALD, "Fed Sets Subprime Lending Limits;" "Banking regulators Friday completed guidelines that call on lenders to strictly evaluate borrowers' ability to repay home loans."  Thus, to us, this article covers the continuing Credit Contraction.  The guidance is "issued by the Federal Reserve and the other four federal agencies that regulate banks, thrifts, and credit unions..."  "The standards, which are voluntary and only apply to federally regulated lenders, calls for verification of borrower's incomes in most cases."  Thus, no more No-Documentation ("liar") loans - definitely a contraction of credit availability, to us.  In fact, "the chair of the Mortgage Bankers Association said the guidelines come with a downside - they will reduce the availability of credit for borrowers...."  Agencies issuing the guidance are The Fed, FDIC, National Credit Union Administration, Treasury Department's Office of the Comptroller of the Currency and the Office of Thrift Supervision.

June 29, 2007 - Stamper Capital Deflation Report - "The Ripple;" 

Based on the table below and recent news, it is fairly to see that the business cycle/credit crunch is in fact rippling as we forecast:

Adjustable Mortgages Resetting==>Housing==>Subprime loans ==>CDO's==>Hedge Funds==>Wallstreet (Blackstone, etc.)==>junk bonds (just starting to see the credit crunch)==>???

To us, about the only area that hasn't started down yet is regular common stocks.

June 29, 2007 - Stamper Capital Deflation Report - "Deflation is Already Here - you just haven't read about it in the press yet;"

                                              Top                          Currently     Decline

Dow US Home Const.Index  5-05-06*@ $50.1     $31.3           -38%

Gold                                      5-11-06 @ $771       $643.50       -17%

Silver                                     5-11-06 @ $15         $12.16         -19%

CRB (commodity) Index        5-11-06 @ 365          313             -13.7%

Oil                                         8-07-06 @ $80.8      $70.7           -12.5%

U.S. Long Bond pric            12-04-06 @ 114.6      107.75         -5.9%

CDO, BBB- rated tranches    1-19-07 @ 96           55                -43%**

Dow Real Estate Index           2-07-07 @ 94.57      77.42           -18%

KBW Bank Index***            2-20-07 @ 121.06    105.80         -6.7%

Dow Utilities                          5-21-07 @ 535.7       498.2           -7.0%     

Dow Transports                     6-01-07 @ 5,326       5,099           -4.3%

     * Note: The I-shares Dow Jones U.S. Home Construction Index ("ITB") commenced 5-5-06 and went down right from the get go; however, most home builder stocks peaked in mid 2005 and are down around 50%.

     ** According to ABX, note, this is the mid-grade tranche; per other financial articles,  "Toxic Waste" CDO (Collateralized Bond Obligation) tranches are down at 35 bid, an 85% drop. and high grade CDO tranches are down about 15%.

     *** KBW Bank Index ("BKX") consists of the 24 largest money center banks & leading regional institutions (Citibank, JP Morgan Chase, etc.)

Also note, "Homeowners with about $515 billion in adjustable-rate home loans will see their monthly mortgage bills rise this year [the remainder of 2007, we believe] as rates reset to higher levels, and another $680 billion worth of mortgages will reset next year [2008], the Banc of America report said.  Of those adjustable rate loans, more than 70% are subprime [per MONTEREY COUNTY HERALD, "Fed sets subprime lending limits," 6-30-07]."  Per another source, the subprime default rate is running around 14%.  Most of those defaults have been after resets.  So we calculate $515 billion * 70% * 14% = $50.5 billion is the expected monetary default over the next six months based on the current run rate - yikes.  The number for full year 2008 would be $680 billion * 70% * 14% = $66.6 billion.  Of course, those are only rough projections based on the numbers we have been given, but they are eye-popping.

June 29, 2007, THE COSTCO CONNECTION, "Getting a Leg Up on Troublesome ARMS;"  this is a great article for us because it wasn't written at all about deflation but we can use it to make a lot of good points. 

Basically the article is about how to deal with an adjustable rate mortgage that is going to be resetting higher - "an estimated $1.5 trillion" scheduled for reset over the next year -  however, all the advice that is given is deflationary - cutting costs and consumption to absorb the cost of rising interest rates:

     "Trim the cable to standard"

     "Cut out the land line and rely on your cell phone"

     "Ask your insurance agent about raising the deductible on your home and car"

     "Consider selling" your property and "downsizing," "moving to another [cheaper]

                 neighborhood, or even renting"

     "Look at each expenditure and ask yourself, 'How can I reduce this cost?'"

We believe implementing any of those suggestions is reasonable and also deflationary.

June 26, 2007 - our own Stamper Capital mid-day "deflation watch report;"  Today gold and silver are down rather precipitously (2% and 5.5%, respectively) and more importantly both have broken very long support lines indicating that deflation is very probably here.  This price action and what is going on in real estate (and sub-primes and CDO's and automobiles) will likely result in deflation being here officially very soon.  Also, the official price statistics have shown a remarkable drop in the rate of increase recently.

                         top                           today           Decline

      Gold          5-11-06 @ $771       $643.50      17%

      Silver         5-11-06 @ $15         $12.16        19%

Of course, to us it would make sense that deflation would arrive officially after the credit crunch (reported previously, see below) had started.

June 26, 2007 MARKETWATCH, "Home Prices Fall at Fastest Rate in 16 years - S&P/Case-Shiller Index Shows Prices Down Annualized 2.7%;"  Well, the headline says most of it.  This is "...the largest decline [in the index] since September 1991."  The index started in 1987.  Too bad the index does not go back to the 1960's.  I would have been interesting to see what it reported for the top in 1974 and for the much larger top in 1979 down into 1985.

We want to point out that according to the article, "The Case-Shiller index is considered a superior gauge of home prices compared to the median sales-price data released by the Commerce Department or the National Association of Realtors, because it tracks multiple sales on the same property and is therefore not influenced by a different mix of homes sold in a period."  We would add that it is probably less likely to be manipulated for political or other reasons.  However, the Case-Shiller index is restricted to 20 cities. 

This measurement of real estate prices is very interesting to us.  Similar to this index, we have documented specific sales of multiple properties in Newport Beach which declined by over 60% from the 1979 top down to the real estate bottom in 1985 (two years after the stock market bottomed).  Those drops were based on actual trades for specific houses in Newport Beach.  When we see official statistics that show a little blip of a drop - we just laugh.  The historical volatility of real estate has been dramatically more than we have ever seen reported; however, this Case-Shiller index may show the true reality.  Of course that index is for the major cities.  We have already reported articles on real estate in small cities citing price drops of over 20 percent in this current cycle.

May 23, 2007, MODESTO BEE, "Car Sales Hit Brakes;"  "First it was houses. Now its cars."  "Motor vehicle sales fell a resounding 7.6% in the United States last month, and analysts said the troubled housing market was a chief culprit."  The article points out that "...the weak housing market is eating into vehicle sales in two important ways:"

"First, consumers who had been tapping their home equity to buy cars during the housing boom are less apt to do so when the real estate market is soft." "Second, building contractors are buying fewer pickups, vans and other vehicles..."

We think that reporting is accurate and, as we have pointed out previously, we believe the "ripple" will be very large.  Here in The O.C. several of the largest sub-prime lenders have gone bankrupt (or are doing so) and have been laying off employees.  We would expect that these employees will be making less at their new jobs.

Also, we do know that real estate sale volumes have dropped dramatically.  We don't think it is a stretch to imagine that real estate agents are seeing their incomes drop since sales volume has dropped.

Finally, although touched upon in this article, the American consumer appears totally tapped out and with the recently raised lending/borrowing standards, it appears that consumption is being curbed, not just with automobiles but in other areas as well.  We expect to be seeing lots of articles on this subject in the near future.  We expect this lessening demand in conjunction with the credit crunch (documented previously) will likely result in falling prices, i.e. deflation.

May 2, 2007, BLOOMBERG, "Rents Peak in Housing Glut;"  "The glut of U.S. properties for sales is about to hit the rental market.  A record number of homeowners who can't sell condominiums and houses are competing for tenants with the country's biggest apartment owners....Competition is already forcing the big apartment owners to offer concessions like two months free rent..."  "Nationwide, 2.8% of houses for sale were unoccupied in the first quarter, the highest since the Census Department started collecting the data in 1956."  "Unsold properties being turned into rental units are creating a shadow market that's driving up the vacancy rent and slowing the growth of rents."  The article points out that not only will rents likely continue to drop but the drop in rents will likely "derail a housing recovery next year."  Its almost a situation where it feeds on itself.  "If you get foreclosures of homes, they're going to be [more] homes for rent."  More homes for rent will push rental prices down - lower rental prices will push prices down.  Really just a reverse of the self-reinforcing cycles that created the bubble in the first place.  Anyway, from a Deflation Watch Perspective, rents are apparently dropping and experts expect that lower rents will  push prices of real estate lower.

April 29, 2007, NEW YORK POST, "Holy Dow! Market's Rise Tied to Dollar's Dive;"  This is the only story in the major press that has pointed this out and we believe it is true.  "This week the Dow Jones Industrial Average hit 13,000 for the first time ever, and the U.S. dollar fell to new record lows against the Euro and the Pound."  "The wall of worry that Wall Street has been climbing is the same one the dollar has been descending."  "In fact, the incredibly shrinking dollar is packing a powerful two-pronged boost for the Dow.  Not only do the Dow 30 companies now derive a record 48 percent of their sales from overseas, the rest of the world is growing much faster than the U.S."  We would point out the the dollar going down is essentially coincident with all the bubbles inflating since 2002, the real estate bubble, the stock bubble, the debt bubble, etc.  The dollar is now at very important lows.  We believe the Fed and the Treasury will have to decide if they want to try to keep the economy from heading into a deep recession (where it is headed currently) by lowering interest rates, and risk the dollar going further off a cliff and giving us inflation as foreign goods go up in price OR will they keep interest rates the same or possibly even raise them to coincide with the expected interest rate raise expected in the U.K. next week to protect the dollar but likely push our economy into the tank.  It seems we are on a bit of a precipice right now.  Its resolution will be very interesting and likely volatile.  If they don't protect the U.S. dollar, they risk a possible reaction of foreign holder's dumping them; thus, we believe the U.S. Dollar will be protected even at the cost of a dramatic drop in the prices of risky assets and a recession or worse.

April 13, 2007, BUSINESS WEEK (April 23, 2007 edition), "The Race to Build Really Cheap Cars;"  Recently, there have been more and more stories we could put on our Deflation Watch Weblog - really too many.  However, this is the best story since:

     The Subprime mortgage collapse began

     The stock market had its 850 point mini crash

     Lenders raised underwriting standards from 100% LTV to 95%

We think this article is a really good read.  It covers many of the changes in the economy from inflation to deflation and from Bull to Bear.  It also uses language specific to deflationary psychology - language that we will highlight for you.

"[Renault-Nissan and India's Tata Motors]...are leading a race to the bottom [of pricing] that could affect the business every bit as much as Henry Ford's Model T did a century ago."  "After years of making their mass-market cars more expensive, the world's automakers have ABRUPTLY SHIFTED into reverse."

Nissan's CEO Ghosen's next challenge, "a future model that would sport a sticker price as low as $2,500 - ABOUT 40% LESS than the least expensive subcompact currently on the [international] market." 

"Low cost cars are the single most important trend in the automotive industry today," says an executive of a major automotive consultant.

"Whatever the lowest sticker price turns out to be, the DISCOUNTING TREND WILL HIT CARS ACROSS THE BOARD, from minis to SUVs." 

"That REALIZATION is NOW DAWNING on the industry's giants."  "If the Japanese company's engineers do their job, the cost-saving strategies will be deployed in everything from Corollas to Lexus SUVs."

Innovation and technology cause/result in deflation - "The KEY is India's low-cost engineers and their prodigious ability to trim needless spending to the bone..."  "You have to cut costs on everything - seats, materials, components - the whole package." "Combine Indian brainpower with Western innovation in design, materials, and processes, and the potential exists for a QUANTUM LEAP IN COST-REDUCTION without major sacrifices in quality."  "The biggest breakthrough: Renault was able to eliminate expensive prototypes and the pricey tooling involved in building [new designs]."  "Renault has figured out how to eliminate physical prototypes for all of its models." - thus, dramatically lowering its costs of development..  

Competition for low cost cars is Widespread - "So far this year, EVERY MAJOR CARMAKER HAS ANNOUNCED ITS OWN 21st CENTURY MODEL T PROJECT."  "Automakers will have to live with a trend of lower-cost vehicles.  It is difficult but that's where the demand is."  We would add that it is a NEW trend and that the trend is NOW - thus it is a major change in trend.

World Trend Change - "To automaker's ASTONISHMENT, cheap cars are also proving to be just as popular in established markets as they are in the developing world...." with Renault moving its low cost cars from sales in emerging markets to western Europe in 2005 with "...buyers [flooding] showrooms to et behind the wheel of the no-frills model."  They are expecting low cost cars to hit the U.S. in 2008.

"THE SHIFT TO CUT-RATE WHEELS IS JARRING for an industry that has fixated for at least a DECADE on premium cars and their fat margins."  The article here focuses on profits and margins...our focus at Stamper Capital, in terms of Deflation, is that customer demand is driving this shift and that demand is for smaller, bare bones, dramatically cheaper vehicles.

Thus, to us, you are seeing a dramatic shift towards deflation resulting from and as an effect of several forces:

     Technology is allowing production of better products at lower costs.

     Globalization is allowing for better products at lower costs.

     Customers are demanding lower cost products.

We have already seen this trend in computer products and electronics, which have seen their prices drop dramatically even as the products have been given more and better features and performance.  We believe that as deflation sets in, customers will be more demanding of lower cost products and will be willing to give up the extra features to pay less.  As for our Deflation Watch, that information is our secondary research, re-interpretation of what this article is presenting. to us.

March 9, 2007, REUTERS, "Countrywide Financial Ends No Down Payment Lending;"  "Countrywide Financial Corp. ("CFC"-NYSE), the largest U.S. mortgage lender, on Friday [March 9, 2007] told its brokers to stop offering borrowers the option of a no-money down home loan, according to a document obtained by Reuters.  A similar BLOOMBERG article (on 3-9-07) points out that "...other lenders that have started requiring borrowers to put at least 5% down on homes include Washington Mutual Inc. and General Electric Co.'s WMC Finance Co. unit. 

That is the news - Our analysis of this news is that this loan underwriting measure is the official beginning of the Credit Crunch and Credit Contraction.  While we realize "at the time" it was easy for these companies to get caught up in the real estate bubble, probably a year from now (or even now) many people will be saying, "what were they thinking?" making 100% loan to value loans.  It just goes to show how even the largest companies can get caught up in irrational business practices during certain cyclical times.  Other related themes along these same lines are the "no-documentation loans" and "sub-prime lending." Years from now, people will think it unbelievable that such respected financial institutions at the time would make "no doc" loans or even "sub-prime loans."

As for our Deflation Watch, a substantial increase in lending standards such as this (going from 100% loan to value to a max of 95% L-T-V) means less loans will be made.  This experience is by definition a credit contraction.  Two other "flies in the ointment" of the real estate bubble are the $1 trillion of adjustable rate loans that are reseting in 2007 and by the end of 2008 and the admission of experts/authorities of the huge amount of underwriting (and outright fraud) to buyers that really did not qualify that happened as a result of the "no doc" and "sub-prime lending over the past few years.

This situation creates a One, Two KnockOut Punch for Real Estate:

     1). Punch One -  lots of supply for sale on the market as defaults step up and properties go back to the banks which then unload them on the market.  Defaults from borrowers who can't make new payments when their adjustable rate mortgages reset; borrowers who purchased 100% L-T-V loans and can't make the payments; borrowers who didn't qualify in the first place, etc.

     2). Punch Two - Less Demand - Fewer buyers now that the lending standards have been raised to 95% L-T-V and those who should not have qualified previously, definitely won't be qualifying in the future.

     3). Third Punch - Buyers who bought on Spec, and this is a very large percentage of home ownership, will be flushed out.  Thus, additional supply (and defaults).

As reported previously around 40% of the recovery since 2002 is widely attributed to the real estate industry.  Thus, we believe the collapse of the real estate bubble will create a huge negative ripple across the economy.  We believe collapsing prices of real estate will most likely morph into deflation in many other categories - certainly prices of other risky asset classes.

February 27, 2007, BLOOMBERG, "U.S. Stocks Plummet as China Triggers Global Rout;"  (This article was posted after the market close on that day). Now you really don't get much out of the word "plummet" these days...over the past few years "plummet" might mean a drop of a hundred points in the Dow Jones Industrial Average.  So to me, this headline understates what happened today (February 27, 2007).  Today, the markets had Huge drops as follows:

          Dow:           closed down 416 points or down 3.3%

          S&P500      closed down 50.33 or down 3.5%

          NASDAQ   closed down 96.66 or down 3.9%

"U.S. stocks plunged, wiping out about $600 billion of market value and erasing all of 2007's gains, after a sell-off in China spread and sparked the biggest rout in four years." - that would be since the drop on the first trading day after Sept. 11, 2001. 

O.K. so the reporting inside the article gives more of the magnitude of the decline and also its global nature but it is still downplaying the significance of the move. But here is another example, the next day's February 28, 2007 THE WALL STREET JOURNAL's Page One Headline on the story is, "Market's Slide Spotlights Risks," which to us totally downplays its significance - to us this very large market drop may turn out to be a huge indicator of what is to come.

This reporting is reminding me of the news coverage of 1929 and the 1930's. During freshman year of college I had several hours between classes everyday so I decided to study the 1929 stock market peak and crash.  The library had microfiche of THE NEW YORK TIMES.  I began reading each paper from front to back starting at January 1, 1929.  It took me about a month but I finally got to October 1929.  As I recall, up to that point there had been essentially very few articles talking about the precarious state of the markets and none at all on the precarious state of the economy.  Even as the stock market was crashing back then, after each drop, the articles downplayed the drops and the politicians assured everyone that there was really no problem.  I was shocked that the media seemed to have completely missed the significance of what was happening.  I continued to read each daily paper through mid-1933.  My conclusion at that time was that if you had been reading the paper in "real time" and had relied on its stories, you would have had no inkling of the financial debacle that was happening or was going to happen - it was like they totally missed it.

It is almost surreal to see the lack of concern in today's headlines.  We will see in the future how significant this turn in the markets really was - we believe this turn is going to turn out to be very significant.

December 19, 2006, THE ORANGE COUNTY REGISTER, "Preview of Coming Subtractions - San Diego deals with retiree health care mess that looms for other jurisdictions;"  Its here - ugh.  Well, what we have been forecasting (and it was not that much of a forecast as it is just math, it didn't add up right) is coming to pass.  This article, which is in the Opinion Section, discusses the San Diego County Board of Supervisors recent decision "to eliminate the stipend for employees who retired after March 2002, when the county increased pensions by between 35% and 60%."  The "stipend" is retiree health care benefits.  Those who retired earlier have had their benefits frozen at the current level.  Importantly, "these changes will result in an estimated $1.2 billion savings for taxpayers over 20 years."  In current dollars, "the unfunded liability will shrink from $640 million to less than $300 million and the annual obligation will be cut from about $70 million to less than $30 million."  To us, this is real deflation - although a lot of it was perception as we have explained numerous times - but, most importantly, it is going to be painful for those whose expected benefits were just cut by, it looks like about 50%.  In his last paragraph, the author chimes in with what we have been saying with respect to the rest of California: "In the near future, the state government, as well as cities, counties and school districts all across California, will be facing the same bleak alternatives San Diego County confronts.  And it looks as if nobody is going to be very happy with the results."  We would add that this is not just a California problem - as we have documented numerous times, this problem is across the entire United States, unfortunately.  Anyway, it appears deflation is arriving, unfortunately.  Batten down the hatches.

November 27, 2006, BUSINESS WEEK (December 4th edition), "A Shock to The System: States and cities are now discovering just how staggering their retiree health-care burdens are;"  This article is pretty much reporting what we forecasted a year or more ago.  What is showing up now is the "shock" at how bad it is.  The article points out that only a few municipalities have disclosed this newly required information so far; however, it does give a few examples.  New York State "might have a liability of $250 billion."  West Virginia "...has promised current and future retirees $8 billion in health care over the next 30 years, could see that figure balloon to $50 billion in 2040." And, "West Virginia has NOTHING saved against that pledge..." The article also points out that "...the new accounting rules don't require states [or municipalities] to fund the projected liability, just to disclose it."  We pointed out previously that the bond rating agencies didn't consider these types of liabilities in their credit ratings since they couldn't get the information - now they will and it is already starting to take a toll.  The article points to Contra Costa County in California which was placed on "negative credit outlook" partly do to pressures from its $2.57 billion retiree health-care obligation.  Remember this required reporting of these liabilities is just starting to come out.  Nationwide some consultants are estimating a "30-year tab could total $600 billion to $1.3 trillion...."  Given the track-records of those involved, we expect those numbers will be surpassed.  The key for us is that these "new liabilities" will have to be funded - money will have to be taken from somewhere else - services, taxes, fees, salaries, etc. and that, as we have said previously, "a pie that was just previously perceived to be very large and growing, will now be perceived as being smaller and shrinking, i.e. deflating" - ugh.

November 27, 2006, BUSINESS WEEK (December 4th edition), "Guess Who's Cutting Deals;"  They are talking about in the automotive industry.  The answer is that BMW is actually cutting the largest deals on new cars right now.  "According to Edmunds.com, givebacks cost BMW an average of $4,179 per car during October [2006], more than Chrysler's $4,136 a vehicle..." 

November 27, 2006, BUSINESS WEEK (December 4th edition), "The Housing Grinch Won't Steal Christmas;"  I wouldn't bet against the grinch this year, myself.  A couple of interesting deflation statistics: The Consumer Price Index...."posted monthly declines of 0.5% in each month [September and October 2006], the largest two-month drop since 1948.  The fourth-quarter CPI will actually be below the level for the previous quarter, a rare event in the past Half Century."

November 27, 2006, BUSINESS WEEK (December 4th edition), "A Good Time to Ask Santa for a New House;" Probably not - probably far too early in the cycle as the down draft is just getting started but the article does contain some recent information.  "The median price of anew home in September fell by 9.7% from a year ago, the largest annual decline since 1970."  "And it looks like prices in several markets will be heading even lower in coming months."  "And, the stock of completed hew homes that remain unsold as of September [2006] grew by 46% from a year ago."  We do not buy that the housing market is anywhere near a bottom.

October 10, 2006, HERALDNET, "The Fed needs to act decisively on hedge funds;"  We are going to skip most of the article as we have covered the possible problems with hedge funds several times on these pages.  The important information in this article is that "The San Diego County Employees Retirement Association pension fund,...had invested $175 million in Amaranth and has now lost about half of it or $85 million."  Of course, that makes the deficit in the previous article on San Diego a bit worse.  We point out (as we have previously) that many, even professionals do not seem to understand the difference between "investing" and "speculating."  It will be interesting to see who else lost money out of the $6 billion in losses hedge fund, Amaranth, racked up in natural gas in less than two months.  We do believe that boards of directors of pension funds could suddenly see the light and all head for the exits at the same time - this is a very very large herd controlling a huge amount of risky assets.  It has been reported numerous times that municipalities and pension funds and their investment managers have been pushed and pushed to ramp up returns to deliver increasing retirement benefits without raising taxes nor cutting services.  In most cases like that, it is just a matter of time before the increased "risk that is taken"  takes away a large part of the principal that was risked.  We see this possibility as a real risk which would likely result in precipitously dropping prices of risky assets.

September 27, 2006, BLOOMBERG, "Pennsylvania Pensions Face 'Crisis', Auditor Says;"  Another article on the continuing and most likely escalating public pension problems.  This one is a bit more interesting because it is related to a new state that we have not covered previously.  Also, this plan was recently fully funded but is now in trouble.  "Pennsylvania's two largest public pension plans, which manage $85 billion combined, face a funding "crisis" because they are spending more than they are generating, state Auditor General Jack Wagner said."  The School Employees' Retirement System and the Stat Employees' Retirement System together are underfunded by $11 billion.  "Both plans were more than 100% funded in 2002 [we note that was near the bottom of the stock market drop - the bottom left of the right tilted W we have written much about on other pages].  By last year, the state workers fund was 93 percent funded and the teachers' retirement system was 85% funded. Each pension plan's total assets were lower at the end of 2005 than four years earlier because of investment losses and a 2001 law that increased pension benefits, Wagner [Auditor General] said."  Then the article goes into a lot of finger pointing; however, on these pages the important points are how is it going to be resolved - lowered benefits, lowered services and/or increased taxes - and does this decrease in the economic pie result in less money to pay for things (either by taxpayers or pensioners) and ultimately result in dropping prices?

September 27, 2006, THE WALL STREET JOURNAL, "San Diego and the SEC;"  Another bit of information the ongoing scandal and pension fund saga in San Diego.  This writing was in the opinion area of the WSJ.  The SEC is about to issue its final report....and then, the city has to deal with its situation.  Currently, "San Diego's pension fund is now underfunded by some $1.5 billion, or about 30%."  Thus, "the nightmare won't end there [with the SEC report] for San Diego taxpayers, who are left holding the bag for the misfeasance of the city council."  The question is, the article points out, how is San Diego going to "balance" this mess - "Will the extravagant promises to city employees be honored without regard to their cost or the improprieties involved in making those promises?"  The city attorney, "a self-described liberal Democrat," Mr. Aguirre has "brought suit in federal court to have some of the benefits granted since 1996 rolled back on ground that they violated federal conflict-of-interest laws."  "As Mr. Aguirre points out, current retirees are drawing 100 cents on the dollar from a pension fund that is only 60% funded."  So, you can see why we believe there will be some  "class warfare" between the taxpayers and the pensioners.  It is interesting to us that the City Attorney fighting for the taxpayers is a "self-described liberal Democrat."  You would expect most public pensioners are democrats; however, we believe this struggle will cut across political party lines as both parties have large numbers of taxpayers.  As we have stated before we expect similar problems are going to surface across the country for states, counties, cities and other municipalities including police and fire pensions.  To us, as either benefits get cut or taxes go up, and/or services are cut, the result will be that the economic pie will have shrunk, unfortunately.  We believe that could be another cause of deflation.

September 25, 2006, STAMPER CAPITAL, "Silicon Valley Outlet Store Sales Traffic Drives Off A Cliff?" - A little "primary research" by Stamper Capital.

August 11, 2006, BUSINESS WEEK (August 21/26th edition), "Cheap Chic;"  "Fed Up with the high prices urban kids pay for sneakers marketed by their basketball heroes, New York Knicks point guard Stephon Marbury is launching the StarburyOne, a $14.98 sneaker he'll wear on the court."  Wow! that is a huge change.  Maybe we should put this on our Major Trend Change Indicators weblog page instead.  The article points out this is 1/12 the price of Nike's $180 Air Jordan XX1.  Of course, Michael Jordan is a bull market icon. I'm not familiar with Marbury's style of play but I would bet it is much more brusing and defensive as opposed to Jordan's bull-market finesse style. Obviously these are not the same pair of shoes, but they are still shoes- both basket ball shoes - both basket ball shoes promoted by basketball stars - NBA basketball stars and the new one is $14.98 and the old one is $ 180.  This may not officially be deflation but it is definitely an indication of deflation, especially if the StarburyOne takes off.

August 7, 2006, PITTSBURG TRIBUNE-REVIEW, "When market sentiment is cloudy, remember: The trend is your friend;"  This article presents lots of facts and figures that conflict and, thus, are used to demonstrate that it is difficult to tell exactly which way the economy is heading.  The article's recommendation to stay with the current trend is made, so that you do not get left behind.  However, the article (maybe cleverly) never tells the reader which way the current trend is heading.  We suspect most would believe the current trend in equities is up.  However, that is not the case.  Our May 17th, 2006 comments (see below for full comments on that date) have proved to be right on:

"The real story is that the stock market and the commodity markets have had sharp reversals [from their early May 2006 market tops] and have almost certainly (to us) transitioned into major downtrends."

The trend since the May 2006 tops is clearly down, with lower lows and lower highs:

                                                               Dow    S&P       NAS       S&P       Dow

% Change from May 2006 Market top:   Indust.  500       DAQ    SmallCap  Transp

                                  to recent bottom:   -8.2%  -8.1%   - 14.8%  -13.8%  -13.4%

                     to following rebound high:   -3.5%  -4.0%   - 12.2%  -11.0%  -13.4%

All lower lows and lower highs;tThus, pretty much all equity indices are in downtrends on an intermediate basis from their early May 2006 tops.

The long term trends of the Dow Industrials, the S&P 500, and the NASDAQ are also down - all having record peaks back in the year 2000. Until those tops are taken out (which we believe will be a long time from now) the long term trend in those indices is still down.

The small caps and the Dow Transports put in record highs in early May 2006.  You can make the argument that their long term trends are still up; but, its clear from the chart above that their short term trends are downward.  We believe their long term trends will turn out to be downward as they "catch up" with the bluer chips.

Many of the commodities, although definitely not all, have price graphs similar to the equity markets:

                                                                                                                  Natural

% Change from May 2006 Market top:    Gold        Silver      Aluminum        Gas*

                                 to recent bottom:    -22.2%    -34.7%    -21.3%         -47%

                    to following rebound high:    -15.9%    -17.3%    -17.6%         -29%

                                                 (*note: natural gas peak was early December 2005)

We believe if equity prices continue to drop and real estate accelerates its recent downward trend, and, if the commodity prices that are dropping are joined by the other commodities (oil, for example) that are still rising or trending sideways, it will turn out that May 2006 was pretty much the top in inflation and the beginning of deflation.  Historically, such turns are not generally officially recognized or announced until many months after they have already occurred.

Accordingly, our message, is still, "Safety is the watchword for this decade."

June 8, 2006, BLOOMBERG, "Intel Tells Customers It Will Cut Prices by 60%;"  "Customers of Intel Corp. said the world's biggest computer-chip maker plans to reduce prices on Pentium processors by as much as 60% to reclaim market share from Advanced Micro Devices Inc."  "...price cuts will start July 23 [2006]."  Definitely, a decline in prices.

May 29, 2006, AOL NEWS, "Retiree Benefits Grow Into 'Monster';" Definitely what we are calling a "reality recognition" article (see below and our Major Trend Change Indicators weblog).  We have been covering the incredible pension problem for years yet this article is the most shocking and direct at exposing the problems faced.  The analysis was conducted by USA Today which "compiled a list of all taxpayer liabilities - federal, state and local - to provide a fuller look at the nation's financial condition.  The numbers are based on official government reports."

"Taxpayers owe more than a half-million dollars per household for financial promises made by government, mostly to cover the cost of retirement benefits for baby boomers, a USA Today analysis shows."  "Like an unpaid credit card bill, the balance grows every year - about $25,000 per household annually."

Importantly, "...the obligations are valued in today's dollars."

"The cost of retirement programs will start to soar when baby boomers.....begin collecting Social Security in 2008 and Medicare in 2011."  -- Just 2 years away, we add.

"American's government obligations are five times what people owe for mortgages, car loans, credit cards and other personal debt."  To us, the only way being so indebted could have come into being is because the average citizen has no clue that it has happened to such an extent (it wouldn't have happened if everyone was solely responsible for themselves and/or their families).  Unfortunately, as this reality becomes widely known, people will realize it is highly unlikely that these promises will be delivered as currently promised - it seems mathematically impossible.  Basically, the benefits promised will be determined by what can be taken from taxpayers themselves - it seems it will all cancel out near zero - the perceived assets of retirement promises will be offset by funds required by the government to pay such promises (or the promises will be deflated).  The old excuse, "we owe it to ourselves" will finally take on the weight of its true meaning - ugh.

Thus, it will likely be that everyone's reality will shift to recognizing that their economic pie has shrunk dramatically by the extent of these newly discovered liabilities!...ugh - very unfortunate and will almost certainly be reflected in the financial markets - sooner rather than later at this juncture.  In other words, we don't think these realizations will move risky asset prices up but most likely down.  As people's wealth perceptions are deflated, so will likely be the prices of riskier assets.

May 23, 2006, BLOOMBERG, "Ford to Pay Highest-Ever Bond Yields to Conserve Cash;"  "The world's third-largest automaker (Ford) is so enfeebled that it will wind up paying the highest interest rate -- and accept the lowest price -- on any Ford bond sold in the U.S. in the last century." 

We have spent a bit of commentary over the past few years on the perils General Motors is involved in and going through.  Similarly to the steel industry and the airline industry, we believe in the "domino theory" for the automotive parts/service industry (which we have also commented on previously - think Delphi) and for the automotive manufacturing industry.  Thus, we believe and stated years ago that we believe General Motors for a variety of reasons (chiefly due to very high levels of liabilities in the face of increasing competition) will go bankrupt or at least significantly restructure itself including cutting salaries and benefits.  As G.M. begins to falter and go under, we believe the pressure on the next in line, Ford, will similarly cause it to falter and so on until only the manufacturers with the strongest true balance sheets (including retirement liabilities) remain.  We have seen this "domino theory" work itself through the steel industry and the airline industry (although it hasn't taken down American Airlines yet, they have already cut salaries and benefits substantially).  It is currently working its way through the automotive parts manufacturing industry and has a good start on the big automotive manufacturers. 

This article highlights a lot of problems that Ford is having:

It is refinancing debt "with coupons as low as 4.95%" at over 10%.

   This will raise its interest expense by "about $90 million a year."

It has $57 billion in debt maturities over the next five years.

It is doing this exchange to "hold on to some of its $21.2 billion in cash.

It lost its "investment-grade credit rating a year ago.." (same time as G.M.)

It "now has $121 billion of junk-rated debt."

   Ford is rated Ba3/BB-

   Ford Credit is rated Ba2/BB-

"Ford's share of U.S. car sales fell to a record low of 15.9% i