Toil and Trouble

I recently completed my tax return (the first pass, at least) so I am not in a good mood. "Nothing new there!", you might say. But I think that it is obvious to most folks in this country that they are working harder and not making any headway. That is why they are raiding the equity in their homes, so they can not only maintain their standard of living, but maintain the rate of increase in their standard of living.

Likewise, the stock market is trying to maintain its upward momentum. And it appears that it is beginning to have a hard time doing so. After a stellar start to the year, it hit a major bump last Friday. Up until that point, the mild pullback was just that: a pullback after a strong breakout. But the worst thing that can happen to a breakout is for it to drop below its support at the point of its breakout. That is what happend Friday. "But last Friday was an options expiration day, which distorts the activity and usually produces a reaction in the opposite direction on Monday. But Monday's reaction was a bounce which only recovered 10% of the amount lost on Friday. Not good. Today's action was a little better with volume picking up, but the gains in the indices still left a little to be desired and leaves them below their breakout levels, which should now be considered resistance. Those levels are 1700 on the Nasdaq 100 and about 1275 on the S&P 500. Watch those levels closely, because if they can't be taken out to the upside and soon (before the end of the month), then watch out below. The next key levels to watch for below are 1644 on the NDX and 1255 on the SPX. If those level are pierced before the end of the month, we're doomed. Doomed, I say!

Introducing...The 40 Year Loan Plan

When the offers for 40 year mortgages appear, the top cannot be far off. This happened in Japan (they even went for 100 year mortgages at the peak of their real estate blowoff) and is happening here now. I won't bore you with my usual verbage, since opinions are not worth the paper on which they are printed. So here are the facts:

1) The ad says that a "$1 million loan will cost $2,529 per month, based upon a 1% start rate, with APR of6.133%. The actual rate is the 12 month average of the MTA which is currently about 3.5% plus a margin of 2.6% (current fully indexed rate would be 6.1%)." A fully amortized loan with a 40 year term would cost $5,500 per month. A fully amortized 30 year loan would cost $6,000 per month.

2) "This loan is a monthly adjustable rate with annual fixed payments for at least 3 years if only the minimum payment is made." (MONTHLY adjustable rate!) Negative amortization is what this loan should be called, although nowhere in the fine print is this stated. Note that the fixed payments are annual fixed payments.

3) "Payments recast at 110% of the loan amount to become a fully amortized payment." Another clever way of stating that this loan in negatively amortized. After three years, you will owe 10% more than when you started. So the monthly payment at that time will be not $5,500 as stated above, but actually $6,050 per month.

4) "Minimum payments are set to increase by 0.075 per year. For example, a payment of $1,000 the first year will increase to $1,075 the next year and then $1,155.63 the next year and so on." Actually, this will only apply for the first three years, because once the negative amortization limit (110% of original loan value in this case) is reached, the minimum payment will adjust to the fully amortized rate for the original term of the loan, in this case, more than $6,000 per month! This assumes that interest rates don't change over the next three years. If interest rates go up, this minimum payment could be even higher. The caps do not apply to this recasting. They will apply afterward, but not for this one-time occurrence of recasting.

So anyone who buys a $1 million house with no down payment and makes the minimum monthly payment for the first three years will see their monthly payment more than double from $2,529 to over $6,000 per month assuming interest rates are unchanged and it will adjust MONTHLY thereafter. Let's assume that the buyer actually has the wherewithal to pay $2,529 a month (a questionable assumption since so many people these days rely upon the so-called "service industries" for their paycheck and it seems unlikely that their income will remain the same if their clients must pony up an additional $3,500 a month to make their mortgage payment. They may not be able to sell as many lattes, perms, personal training sessions, massages, spa treatments or even mortgage refinancings.) How much house would $2,529 per month actually buy? About $442,000 worth. So here is my prediction: All of these $1 million homes in California will be selling for $442,000 before this cycle is over. (Sorry, but I couldn't resist throwing my shot in at the end!)

We Have a New Spokesperson

Well, I apologize for not updating earlier, but the holiday season is busy. As has the first market session of the new year. But more about that later... First things first!

The title of today's misguided rant was inspired by this article concerning a famous actress' "investment" choices. The basic story is that in that auspicious year of 1999, this certain thespian went bankrupt! Now we hear about her touting the superiority of real estate over stocks! What gall! What hubris! What nerve. (Sorry, I just ran out of exclamation points.) Now, if that isn't an indication of the top being in place, I am not sure that we will ever see a clearer indicator.

Now, for today's impressive rally! (I am following the modern trend and borrowing a few exclamation points!) The basic guideline is that the year goes as January goes and January goes as the first week goes. And especially in a holiday-shortened week, the week is likely to go as the first trading day. But another rule of thumb is that Friday's action is more important than Monday's. So we will have to wait and see how Friday and later the first month of the year goes, but my concern is that this rally may not be sustained. Volume and breadth seemed quite good for this first trading day of 2006, so we should respect the early indications of strength. But the action of the last quarter of 2005 had the earmarks of a terminal phase of a move, with volume that was medicore, occasional days of distribution and narrow leadership. It is not surprising that we should see a reaction, especially when we touched key levels of support at 1635 on the Nasdaq 100 and 1258 on the S&P 500. The important test will be whether this move can take out the recent highs, which happen to also be near pretty key levels. As usual, I have my doubts, as I have a feeling that this rally will not survive this week, but it is best to wait and see. The first key test is Friday. If we rally strongly to end the week, maybe this is the real deal, but if as I suspect, the market experiences softness to end the week, then I will be vindicated and the time to short this market will be at hand. Meanwhile, keep the powder dry and possibly do a little selective, opportunistic selling.

Finally, the most worrisome development is the action in the oil market (and the actions of the Russians, who are bound to flex some muscle after being pushed around in the "Orange Revolution"). This is worrisome in light of the consensus that the Fed is almost finished pushing up interest rates, while long-term rates remain well-behaved. But what if circumstances force the Fed to continue raising rates longer than anyone expects. That is exactly what happened last year and I am taking the contrary opinion that this is exactly what will happen this year. This will be the test of the new Fed Chief and my premature opinion is that it is a trial in which he will be found wanting. Alas, with the conditions WE have created (yes, I am blaming you and I), it is unlikely that any mere mortal could master the balancing act required to bring the global economic distortions which currently exist back into equilibrium.