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Mark's Market Blog

8-3-14: Argentina Defaults. Again.

By Mark Lawrence

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This was our worst week in the stock market in two years, down 3.3%. Stock brokers are literally jumping off curbs. People are eating apples on the sidewalks. Why? Argentina defaulted which made everyone yawn, the employment numbers came out and were rather pedestrian, What's next? Some are calling for a crash, perhaps as much as 50%. Not right now. Crashes are instigated by something, like the Fed raising rates or some external shock. We don't have any of that right now. The bull will continue in a few days.


S&P 500 February 8 2014 to August 1 2014

Margin debt - the amount of money people have borrowed to play the stock market - is near an all-time high. Although I continue to think this is a bull market, the signs of a top are gathering. I don't think this market is a good place for most people to be.

About ten years ago Putin appropriated the assets of a Russian oil company, Yukos. Monday The Hague's arbitration court ruled that Russia owes Yukos shareholders $50 billion - 2.5% of Russia's GDP. Enforcing the order is a completely separate issue. Expect Yukos shareholders to try to identify and seize Russian assets. This should be a real circus.

Ukraine is rapidly running out of money. Their east is industrialized but in the outmoded Soviet style: out of date factories that inefficiently make undesirable products and enormous pollution. The west has a more vibrant economy but is being bankrupt by the war effort. Russian separatists are boxing up everything of value they can get and shipping it back to Russia. What factories there are in the west are accustomed to exporting to Russia and their price and quality cannot compete with the Chinese in European markets. Ukraine does not currently seem to have an economy that can support their people.

Argentina defaulted. They had a negotiator in New York but of course after several years of fighting, the hedge funds have Argentina on the mat now and there's no way they're going to concede anything. The Argentine negotiator packed up and left. What happened? In 2001 Argentine defaulted and then made an agreement with 93% of their bond holders to pay them back at some very low price, like 10 cents on the dollar. Hedge funds bought up the remaining 7% of the bonds cheap and have been trying for a few years to back Argentina into a corner. They succeeded. Argentina's new default was determined to be a "credit event" by the ISDA, triggering about a billion dollars of credit swap payments. Now the hedge funds want to get paid in full, basically giving them a profit of roughly sixteen times their investment. I dislike Argentina borrowing money and thinking they can just default every 20 years or so - the world does not owe them a socialist paradise. But I dislike the hedge funds even more and I wonder why they're not all put in jail. What's next? This is just another step in the negotiations. This most likely won't be settled this year. Most of Argentina's bonds have a clause that if they pay anyone in full they have to pay everyone in full. That clause expires on 1/1/15. The hedge funds won't settle, and they're not going to get 100% until that date. I dunno what's next, but everyone has cooked their bratwursts, iced down their beers and settled into their folding chairs to enjoy the game. It won't be called early. Everyone has their own local jokes - Wisconsin is all Germans and Polish, so it's polack jokes. In Canada it's Newfy (New Foundland) jokes. In Texas it's Aggie (Texas A&M) jokes. Anyway, this reminds me of the Aggie that comes home early and finds his wife in bed with another man. He leaps for his end table, pulls out his gun and puts it to his forehead. His wife and the other man giggle. He says, "Yah, you laugh now. You're next!"

Obama's administration is in an uproar over "inversions:" that's where a US company buys a smaller company in low-tax Ireland or some such and then uses the European company as a base to avoid US taxes. They want to outlaw this, for example proposing a law that if 51% of your business is in the US than you owe US taxes on everything. I don't think this will work. Businessmen can form legal organizations in weeks and there is an entire industry of lawyers and accountants who do nothing but figure out how to beat the IRS. This is turning into a serious issue as about 5 times as many companies are planning to do this in 2014 as in 2013. Large companies already have $2 trillion parked outside the US in subsidiaries, avoiding taxes. To make this end we would need a world government that enforced one tax code for everyone, everywhere. Meanwhile Ireland sees this as a chance to import American companies and jobs and is doing quite well.

Dollar Tree is buying Family Dollar. Both businesses are suffering from the recovery - middle class families are making a bit more money and shopping again at more upscale stores, and lower class families have seen their income drop by 1% since 2004. Walmart has now had 5 straight quarters of declining sales and Goldman Sachs is not predicting the slow decline of Walmart and Target. You may recall in my last motorcycle trip through the south, all I saw in small towns was dollar stores and 7/11s - those people have almost no alternative but to shop there, yet the stores are still losing money, closing stores and laying off workers. The Fed would apparently have you believe they're focused on jobs and recovery, but half our population isn't experiencing the recovery at all.

In a recent poll the Washington Post found that Darth Vador had higher approval ratings for our next president than Hillary. Well, no wonder - she's more like the emperor imo. And Romney would now beat Obama. No big surprise there, Obama has managed to alienate nearly everyone. Blacks and Latinos still like him; the rest of us are waking up with a hangover wondering what on earth we did last night and how long it will take to live it down. Future democrat candidates will have to prove they're not going to be like Obama. At least until Washington turns 14m illegals into voters and their birth rate turns us into a banana republic.

Sao Paulo Brazil is experiencing a water crisis more severe than even California's. Brazil estimates that Sao Paulo has 100 days of water left; their largest reservoir is empty. Side effects include a huge increase in natural gas to compensate for the loss of hydro-electric power and a 70% rise in coffee prices as their crop, 35% of the world coffee crop, gets decimated. It's all about water, we're going to hear more stories like this in the future, not fewer. Some would have us believe this is global warming rearing its ugly head; perhaps. I think it's a world population that has nearly doubled in my lifetime. Increasing world population directly increases water demand, of course; in addition increasing world population increases air pollution particulates which affects cloud and rain formation adversely. In particular China and India have horrendous air pollution from burning coal and diesel oil and are having severe drought problems - these are almost certainly related.

China also has a water crisis, but theirs is substantially self manufactured. WIth 20% of the world's population but only 7% of the world's fresh water, you might think they would be careful with their water. 90% of the ground water in and near cities is polluted, 70% of their rivers and lakes. Chinese do not have a culture of caring about each other or their environment. I can't imagine what these people will do to the Arctic if they're allowed a major presence there. You've often heard "you are what you eat." The favorite food in China is pig.

Maxine Waters (D Los Angeles), whom I have previously called a sink hole in the IQ landscape of congress, has done it again. Speaking at the Islamic Society of Orange County, she said those who oppose sharia law in the US are "bigots" and "fear mongers." Sharia is the muslim code handed down by Allah that allows for killing teenage girls who discredit the family name by dating the wrong boy or killing Hindus who refuse to convert to islam. Clarence Darrow, the lawyer in the Scopes monkey trial once said, "When I was a boy I was told that anybody could become President. I'm beginning to believe it." Me too.

Zillow - the web site that tells you what your neighbor's house is worth, has just bought Trulia, a web page that helps you search the MLS listings for a house. All those women you know who have real estate licenses and try to make money selling homes? Their days are numbered. Conventional real estate companies charge their employees monthly dues, so the more agents they have the more money they make. They thrive on incompetent agents who sell almost nothing. Meanwhile the top producers demand a larger cut of the commissions. You can't tell from outside the agency who are the top producers who know the local market and who are the almost useless hangers-on. But soon you won't need an agent at all to find yourself a bunch of houses for sale and whittle them down to a few you're really interested in. Wall Street projects that over the next 2-3 years this combination will gut the real estate industry. MLS is so last decade.

Too big to fail? The government accounting office released a report today that the biggest banks are 25% larger today then just before the crash. And they're still getting subsidized, to the tune of $83 billion per year in the form of low interest rates.

A little story from history: In the 1960s, the air force put out a request for bids for a new transport jet. Lockheed won with the C5. Boeing was left with a substantially completed and paid for design for a big plane that no one seemed to want. They had some meetings, and in a move typical for Boeing from time to time, they decided to bet the company, punch some window holes in the sides and turn it into a huge passenger plane, the 747. Lockheed and McDonnell Douglas were ecstatic, they figured this mistake would drive Boeing out of business. In fact the 747 was a huge success and still sells nicely even though the basic airframe is now nearing 50 years old. The quick and highly profitable acceptance of the 747 left Lockheed and McDonnell Douglass standing around with their pants down looking stupid. Lockheed quickly decided there was a hole in the jets offered - nothing fit in the big gap between the 707 and the 747. They decided to design an intermediate plane, the L1011. After about three years of design Lockheed called in the airlines for feedback and to gauge interest. American Airlines said it looked fantastic, could they take the plans home for the weekend for further study? They took the plans to McDonnell Douglass and said, "How much do you want to build us this plane?" The next monday McDonnell Douglass announced the DC-10. The DC-10 announcement drawings are a better dimensional fit for the actual L1011 than the DC-10, they just changed the rear engine and labels. When airlines are making orders price, range, seating capacity and delivery date are the important points. McDonnell Douglass was a couple years behind and having to compete on delivery dates. So they cut a bunch of corners: the landing gear was not a new design, it was taken off the DC-8 and doubled up, hence the harsh landings of DC-10s. They asked for and received an abbreviated FAA certification schedule. The DC-10 actually had a first flight before the L1011, which gives you some sense of how rushed this project was. Unfortunately in the long run the rush showed - there were numerous crashes due to failure of cargo doors and cabin depressurization, and finally the O'Hare crash where an engine fell off on take-off and all 271 passengers were killed. There's an engineering story behind that too, one which is rather damning of McDonnell Douglass, but I'm not going to get into it today. Suffice it to say that after the 1979 O'Hare crash not a single DC-10 was ever again sold for passenger use, and the remaining passenger versions were quietly converted over the next few years into cargo planes. In about 2001 Airbus decided there was a similar situation to the 1960s - an unfilled need for a bigger jet - and they started design on the A380, a plane that dwarves even the 747. There was again much skepticism in the industry about the viability of such a huge jet, the requirements for runway and terminal modifications, and the logistics of jamming 500+ people into one little tube. The plane first flew in 2005 and was delivered in 2007. Generally speaking you need to sell 300 to 500 jets to pay for the design, then you get to make money. Boeing has sold 1500 747s to date. Airbus has sold 135 A380s to date, roughly half of those to one airline, Emirates. Just this week Airbus canceled an order for six A380s from Skymark of Japan. Japanese airlines have historically been very loyal to Boeing; this was a tough sale and considered to be Airbus getting a foothold in the Japanese market. Now their foot has been ejected and the door slammed shut. I feel confident the A380 has not made money and never will - Airbus misjudged. They won't go bankrupt, they're backed up by the treasuries of France, Germany and the UK. But they're not having a very good time of it right now. The Boeing 787 - the carbon fiber plane - has had a rough start with engineering and production delays and battery problems. Even so 162 planes have been built from 2012 to date and they have strong orders for the future. Airbus has responded with a new advanced plane, the A350, but that too has met with a profound lack of interest from the airlines. Times are good right now for Boeing and Seattle, much less fun in Toulouse France. They have a joke in Europe: Heaven is a place where the engineers are German, the police are British, the cooks are French, your banker is Swiss and your lover an Italian. Hell is a place where the engineers are French, the police are German, the cooks are British, your banker is Italian and your lover a Swiss.

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