Southwest Ranch Financial, LLC
October 2008 Update
The S&P500 is at 1166 on 30-September-2008

This page can be linked to at   ( www.swranch.net/emails/2008-10.htm ).

The Southwest Ranch Financial Market Alert Timing Model is out of the stock market. 

Year to date, the S&P500 index is down -19.3% and the SWR Balanced Portfolio is down -9.3% (with half the stock market risk.)

Here’s the year to date performance of the SWR Balanced Portfolio by asset class.

As of 9/30/08

Market Alert Model
The SWR core model is out of the stock market.

Year Ahead Timing Model
The YAT model is used to indicate periods of buy opportunities within the Market Alert Model’s timing cycle. The SWR Market Alert Model always trumps the YAT model. The YAT model is neutral.

Interest Rate Model
The SWR Interest Rate model is negative on interest rates and long bonds.  

Gold Model
The SWR Gold Model is positive on gold.

Market Warning
I'll repeat my previous warnings. Exit all stocks indexes. Avoid all bonds with a duration greater than one year. Hold cash and gold and limited natural resource stocks.

The Carnage Begins
The S&P500 is now down about 25% this year. Gold is moving up. Both events were consistently predicted by SWR all year. My models show each trend is still in place. Will Paulson's bank bailout make a difference to stocks? Not at all. It will delay the collapse in stock prices but will not prevent it. Would the bailout make a difference in the credit markets? Yes it would. Again, it would only delay the inevitable.

The American people have had it. The real reason Paulson couldn't get his plan through is the people know they've been consistently lied to by the politicians. The $700b is a drop in the bucket to what is really needed and the taxpayer will never see a dime of it again. The Wall Street pros say the bailout is needed because the credit markets are frozen and the markets can't price assets. That's probably because many assets are worthless.

This is more than a housing issue. The housing bust is depleting bank capital but the other issue is what we don't see. What we're really talking about are mountains of worthless bond insurance purchased by financial institutions and sold by Wall Street. Scamsters made billions in this business. Banks, pension funds and who knows else bought corporate bonds and purchased insurance to cover the bonds in case of default. These Credit Default Swaps supposedly insure debt against default. The guys who sold the bond insurance even bought insurance to cover their own insurance obligations. The finance guys assume a low level of actual bond defaults and say they are properly capitalized and sell more of it.

With a thin veneer of cover, the bond insurers pocket the premium income and distribute it to the partners and major investors. The whole game was unregulated. Everybody played along. If you bought bond insurance you didn't need to hold a large contingency base of capital in reserve. You could loan it out and make more money. Paulson understands the game and knows the players. He's part of the problem. He knows the truth and must certainly realize that there is inadequate capital to back up the liabilities.

Nobody knows who bought insurance and who will be short of capital when the economy goes deep into recession and corporations start to fail. The bond insurers will get a telephone call from Bank & Trust, Inc. and will hear the bank say it's time to pay up on a defaulted bond. All the bank will hear is a hang up click. The bank will have to write off the debt and take a hit to profits and their own capital base. Thus, failures lead to cascading failures. What we're witnessing today are competent bankers who won't loan money to another bank if they doesn't trust the others credit worthiness. Will the government pay everyone's debts to the tune of trillions?

Most of the house republicans who said no to Paulson's plan are afraid of losing reelection because constituents oppose the bail out. Many congressmen voted no on principle.

The Paulsen plan was a cynical scam to extend the finance bubble and to pass it off onto the next president. They called it the Troubled Asset Recovery Plan or TARP. A tarp is used to cover things up and the name was probably an inside joke at the White House. They were certain congress would pass the bailout over the first weekend because fear tactics have served this administration well. The plan would bail out the worst domestic and foreign banks. The worst offenders would get off the hook and the language in the plan said that no court or congress could ever go after the Treasury or the bank executives for fraud. Here's the cover up wording.

"Decisions by the Secretary pursuant to the authority of this Act are non-reviewable and committed to agency discretion, and may not be reviewed by any court of law or any administrative agency"

Of course, congress smelled a rat but many voted for it anyway because they are corrupt and only care about the election. The Democratic leadership went along with it and that should tell you what is coming after November.

A variation of the bailout still may pass. At this point it doesn't matter. $700b is simply an inadequate amount of money to cover the many mortgages and other obligations that will default over the next five years. Treasury will have to come back time and again for more money. The plan would have propped things up for a while but what's the point. The Treasury and congress can't repeal the business cycle. It's more powerful than any central bank and even all of them together. The banks have to fail and houses have to fall in price. It can't be stopped; only delayed. We've been distorting the business cycle with deficits and phony budgets for many years.

The New President Amid a Dark Cloud
As the recession/depression bites deep into every town in America, people will become very angry at those who've done well. If you have savings and had the smarts to exit the stock market and manage to avoid the bond market decline and the coming currency collapse ... the few of you left had better keep a low profile. Hero worship of rich people and speculators will be a phase of American popular culture long gone. Even modest savers who manage to keep up their lifestyle will be envied.

In this environment I expect punitive taxes on the very rich. People with savings will be means tested and those above certain thresholds won't receive all their Social Security. Medicare won't be available to many. America is broke - we just don't know yet how bad it is. And by broke I mean many people are dirt poor broke and only a paycheck away from the street.

Obama will likely win in November. He's a smart, strong willed guy and much more formidable than people think. Schooled in Chicago style hard-ball politics he knows how to hide and play his cards. He's also a populist with a burning zeal to set things right - as he sees it. Obama is the polar opposite to George Bush's tendencies toward cronyism and acting without thinking. I'd guess Obama will be very careful and methodical. I suspect he's an income redistribution type of guy and will employ the best minds in government to extract it from those who got it.

What To Do
The recent stock market declines are just the first phase of our coming economic slippage. Many investors have lost over 25% on their stock portfolios since autumn 2007. They've run now from stocks and into bonds. Some think they can hide out in TIPS or money market funds. As the recession grinds down corporations, bond rates will rise due to defaults. The credit default swap insurance purchased by financial institutions will have headline failures. Unemployment will rise and the government will run trillion dollar deficits year after year. At some point foreigners will give up on providing cheap money to the Treasury so Treasury will just print money. Tbond rates will go up. Holders of bonds will lose as rates rise. The dollar will decline. Sitting in bonds exposes the investor to currency risk and interest rate risk and that includes TIPS.

I've called the first phase of this process The Big Markdown where asset prices drop in price. We're only part way through it. Phase two will usher in massive bond defaults and job losses. Phase three will include a currency collapse when the dollar is dropped as the world reserve currency. In phase one, asset prices fall. In phase two institutional promises to pay debts like pensions, annuities and bond insurance fail. In phase three the currency fails and systemic economic failure occurs and most probably amid very high inflation. Phase three could be avoided if there was international cooperation on debt rescheduling and America made a national commitment to financial solvency. Failure is not inevitable if internal forces were properly directed and external forces were cooperative. I doubt we'll see the optimistic scenario. That's because the oil depletion crisis will arrive at about the same time and stress economies across the globe (with some notable exceptions).

I think we're facing many years of negative interest rates. This is a condition where the rate of inflation exceeds the rate earned on treasury bills. Thus, holding cash will be a losing game. Gold will move up with inflation and will move dramatically upward as the dollar weakens. The only other asset likely to match or exceed gold's rise will be oil. We're probably near or past the point of maximum world oil production or will be within a few years.

As investors, our primary issue is to contemplate the consequences and decide what must we do now. Let me first make a statement so you know where I stand.

I firmly believe that most investors reading this eletter will be essentially broke within ten years. Your money will be lost to inflation, a dollar decline and a series of failed defensive asset repositioning's that won't protect your savings.

Each phase of our national insolvency has a particular course of action to follow and missing the transition points will quickly erode asset values. That's why very few will survive with meaningful liquid assets intact.

I'll offer my opinion on what to do but with the caveat that I could be wrong and possibly very wrong. You should and must countercheck anything I say against the opinion of a competent professional and consider all sides of the arguments carefully. I don't have psychic powers or an all knowing ability to predict the financial markets. At turning points, I've been right or lucky so far but may be wrong next time. With that in mind, let's go.

The Three Fuzzy Phases of an Economic Collapse
Phase One: This phase started in 2000. The Internet bubble popped and stocks started down. George Bush took office in 2001 with a laundry list of wars to win. These schemes were cooked up by Dick Cheney and various conservative think tanks. Some deliriously dreamed of an American Century or Pax Americana. Others were oil men keenly aware of the depleting oil production problem and wanted Iraq's oil. Some were honest idealists hoping to spread sound Christian values or conservative ideas to create a more civil society and one with sound money. These good people were the first victims of Bush's distorted world view and betrayal. Privately he called evangelists "wackos" (book source: The Bush Tragedy)

The war plans existed prior to 2000 and this is documented. 9-11 provided the perfect opportunity to set the war plans in motion. It was suspiciously timely. From 2002 to 2008 Bush doubled the national debt and amid weak market regulations instituted prior to his administration. He further weakened the rules. He was warned in 2002 by his Treasury Secretary Paul O'Neil that his plans were potentially financially catastrophic for America. O'Neil was fired.

Bush should have listened to O'Neil, Volcker, Rubin and many others in 2002 who strenuously warned him and the world of the consequences of his actions. Nelson Mandella said Bush had no ability to reason and would lead the world into wars killing many. Bush would have none of it. The dollar declined 40% between 2001 and 2006. The wars were all off budget to hide the true costs. The story has been told by others so I won't go on with it any further. Suffice to say, the crazy spending was the cause of the housing boom and the lack of regulation exacerbated the bond insurance scams and many other acts of financial malfeasance. These problems are now collapsing onto Bush just as he prepares to leave office. The nation is experiencing massive assets losses in housing and stocks.

I started my SWR web site in 2003 and warned about the wars. I'd regularly lose 10% of my subscribers in months when I criticized Bush. Never bothered me. I had bought gold in 2003 in the mid 300 range knowing this guy had a Manchurian Candidate personality. In autumn of 2007 I began warning of an imminent stock market decline (the eletters are still on the site). My subscribers avoided the falling stock market.

Phase Two: This phase is just starting with some overlap with phase one. During this phase corporate bonds will be crushed and stocks will continue to fall. I have a chart on the SWR site showing how rates usually rise as the spread between 10 year Tbonds and 20-30 year corporates exceeds 1.5% or so. The historical spread is .86% with a standard deviation of .40%. Two SD takes it to about a 1.6% spread. This is very rare. We are now at 3 SD with the spread over 2%. This only happened once before in US history - in 2001. I believe a wave of corporate bond failures and rising rates is just beginning and is irreversible. The weakening economy will be the trigger. When the bonds fail and the credit insurance fails, we'll see a massive credit panic and the start of a depression. The stock market will crash to unthinkable levels. Pension funds will fail. The debt will be assumed by the federal government. This phase could occur at any time and quickly transition to phase 3. Hold cash in treasury bills or short term insured deposits. Avoid all bonds with any duration longer than one year. No stock market in the world is safe.

Phase Three: This is the phase where you must take decisive action because time will be very short. Those not acting promptly might be financially destroyed. I was in the bullion business in 1978-82 as a scrap dealer, I'd have older people stop in to talk. My shop was in an a neighborhood with some foreign born WWII survivors of German prisoner of war camps and Holocaust survivors. These were the ones who didn't flee and got caught up in it. Their stories made a deep impression on me and caused me to always be alert to governments that work against basic justice and the needs of the people. The incompetence and malevolence that has infected our congress and administration has brought this nation to the very brink of disaster.

One of two things will happen. Either inflation will roar and financial assets held as dollars will lose value quickly. Or, deflation will set in as a resolute leader refuses to take the nation into the financial destruction of hyperinflation. Inflation is much more likely than deflation. We have to wait and see which way it goes. Like I said, Obama strikes me as a resolute man whereas McCain, my state senator, is tough talking phony. Whoever wins, it won't make much difference because the circumstances will force the course taken.

This phase will be marked by the abandonment of the dollar if inflation occurs. There will be plenty of warnings before this happens but most people will ignore the clear warning bells. The Treasury will be pressured to print money to help the unemployed, to support the failing credit markets and to take over paying private and public pensions.

Gold will hold value but will be hard to obtain. This is already happening - call any coin dealer and you'll see its true. There's weeks of wait for gold coins. When panic sets in people will lose fortunes to con men who won't deliver promised coins.

The government might take punitive action against gold by taxing it heavily on the sale and resale. Speculators will not be popular. All gold should be held in physical form in a safe deposit box or in allocated units in your name outside of the country. Canada is a good place.

The best investment during this period will probably be oil. When the world economy starts to dive, and this recession will be global, oil prices could fall for a while. At a certain point, when prices are depressed, I'd buy an oil etf like USO. This will be a play on the dollar and oil depletion. Buy in three groups to avoid committing everything on the way down. The advantage to buying oil over gold is the price is now headed down while gold is going up. This divergence is unusual and potentially profitable. In addition, the government can't manipulate the oil market like gold and can't outlaw it or tax it. It's an excellent proxy and will win big in a dollar collapse and during inflation. You want to buy USO in this phase and not in Phase Two. During an asset price deflation, cash will rush into the dollar and other strong currencies. However, the currencies can and will be manipulated by the central banks to prevent a massive bank run in any one country. This agreement will hold for a short time. During this phase currencies will win over stuff like oil at least for a while.

Another option is to hold money in various currencies using etf products or mutual funds designed for that purpose. You can check out FXF, FXC, FXY and the fund merkx although it's heavy on Euros. I'm cautious on the Euro because some countries in Euro Land also have huge debt problems. I might be wrong to avoid FXE.

Right now, the currencies and oil are declining against the dollar as cash rushes to safety. Under no circumstances would I put everything into one pot. I would never own all gold or all USO. I'd mix it with currencies and some prpfx and cash. A little gold or oil will go a long way. Use good sense at all times and don't get greedy. The objective is to maintain purchasing power and not to get rich. I know many people will ignore that injunction and you'll see for yourself what happens to them.

The issues I discussed are very important to retired people and the elderly living on a fixed income. Young people starting careers or in their first home will not be as severely impacted by a financial panic if they can keep their job.

Charts

PRPFX is much less volatile than gold or stocks and is holding it's own in a tough market. The charts below show the rate of return over a period.

Prpfx (The Permanent Portfolio) is even for the year whereas gold is up 20%. The fund holds 25% precious metals but its balanced asset mix smoothes things out. I really like this fund for this tough period.

Stocks have been crushed over the last year. Despite holding 30% in equities, prpfx is even yet stocks are down over 25%.

Gold and oil often move together but they're now diverging. Gold is up 5% in September 2008 whereas oil is down about 12%.

Oil can often have price swings of 30-60%. USO may be a good inflation play in Phase 3 if things go to high inflation and amid reckless spending and bailouts. I'd buy USO in three stages. Buy some when the price rises above the 50, 100, and 200 day moving averages. This strategy would have worked well in April-July 2007. Once in oil, stay in rather than trying to trade it. We just want to get in at a reasonably low price range. We want to buy on the way up in stages. In phase three oil is a good inflation hedge.

Reforming America
America's debt problems, wars and general level of poor leadership have been caused by greed and incompetence. Our public officials are bribed by lobbyists to work against the public interest. It's essential that we avoid the mistakes of the past. I'd propose some simple ideas for this country. One to fix what's wrong and the other to set a new direction.

1). Require the public funding of all federal elections. No candidate may accept private funds or provide their own funds in excess of a percentage of the public funds. This will reduce the influence of lobbyists. Public officials may not work as a lobbyist for a private employer for three years after leaving office. Public officials may not work for a private employer for two years after leaving office if they accepted campaign contributions from the organization.

2) Set a national objective of total energy independence from imported oil and gas. I'd exclude Canada and Mexico from the rule since they are close neighbors.

Other Notes
We are not in a commodity bubble. Bubbles imply a huge demand that's swamped by supply causing prices to fall.  In oil, gold, and food there is no huge oversupply of product so this recent market decline isn't caused by over supply.  It's a decline caused by fear and the need to raise cash but it's not a bubble. Regardless of what happens in world currency and commodities markets, nations with natural resources to sell will gain foreign currency exchange.   Nations that manufacture more than they consume will accumulate exchange reserves.  In an economic recession, people still need oil and other things.  This will be much more important than having a lot of banks.  I don't buy the story that commodities are dead.  They are very well priced right now. Therefore, hold the currencies of nations that don't have to borrow and that have essentials  to sell.

A subscriber sent me a link to a new asset allocation tool. It's much slicker than the one on my web site but lacks gold. Be aware that the data prior to 1980 is a guess because the indexes didn't exist at that time. http://www.assetplay.net/financial-tools/backtest.html

The years ahead will be difficult. Our objective is to maintain purchasing power for now. There will be better days. At some point we'll be able to lock in high interest rates and low stock prices.

Best Regards,
Southwest Ranch Financial, LLC    (www.swranch.net)
Tom Gleason, Manager & Researcher

Author of: How To Invest If You Can't Afford To Lose
Tom Gleason has degrees in finance and information systems. He's worked as a bullion dealer, fraud investigator, real estate appraiser and financial analyst.

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Disclaimer:.
The views expressed are the opinions of Southwest Ranch Financial, LLC. SWR is not a registered investment advisor and nothing published by SWR should be considered personalized investment advice. Investing involves risk and the future performance of the SWR models cannot be guaranteed. You may lose money following the recommendations. Any investment recommendations made by SWR are for informational purposes only and you shouldn't act on a recommendation without consulting with your investment advisor. It's your responsibility to review the prospectus or relevant financial statements.  SWR does not receive any compensation for mentioning stocks, funds, or financial products. SWR may have bought or sold investments prior to publishing its research.

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