Keep A Defensive Posture

Fox Business Channel...October 15th. Mark that date down.

Did I tell you Pepsi just admitted that their bottled water...AQUAFINA...is really tap water? People are up in arms. You mean to tell me they didn't know bottled water was a sham?

Congress slipped 1776 pet programs into a Defense spending. Obviously, house members were celebrating the year 1776...NOTHING HAS CHANGED. What happened to promised reforms?

So..you want to know what happened to cause the fallout in housing...in lending...in credit? It is simple.

1) A friend of mine, we'll call him Cosmo Kramer, received a $250,000 mortgage to buy a small house in Boca Raton, Fl. There was only one problem with this. Cosmo had about $19,000 in savings...and was not working at the time. The lender did not ask for income statements nor a net worth statement. Cosmo just signed on the dotted line and moved in. His payment was very low because he was given a no down payment...interest only mortgage. The lender told Cosmo he was now the proud owner of a new house. WRONG! This type of mortgage is nothing more than RENT...not ownership. You never build up any equity while taking all the risk. Cosmo no longer lives in the house. What happened to this mortgage? Well...it was sold...it was sliced and diced...and it was packaged for people to buy. Hundreds of billions of dollars of these loans were made...if not more. Lenders came up with these psychotic loans because average Americans could no longer afford home prices that had skyrocketed in recent years...so they came up with what I call the "ROOMS TO GO" loan. You know...Buy a sofa and don't pay for 2 years. Combining giving loans to people who should not have been taking them...and the fact that housing has headed south...and you have a recipe for disaster...and that's what occurred. I blame the lenders...I blame the overseers...I blame Greenspan who said subprime was fine...and anyone else who enabled this to happen. These packages of mortgages were bought up by the hedge funds you have been hearing about. The problem is that there isn't a real market for them. Prices are arbitrary...and people like Bear Stearns hid the problems by naming their own price until the pressure was too great. Fast forward to today. Those same lenders that would give anyone any amount of money 2 years ago...are now asking for volumes of paperwork...going from one extreme to the other. We now have restrictive lending...and that hurts the economy.

2) But let's not stop there. Let's talk about all these "buyouts" that have been occurring by the private equity lovelies. These maggots...and yes, they are maggots...have also created a problem. First off, you need to know that they create nothing. They buy companies...pile on mounds of debt...use that debt to pay themselves big fees and dividends...fire a ton of people...and then try and sell the company or bring them public again. NEAT-O! I am sure not every deal is as bad as this but many are. I must make note that in Blackstone's case, you have a company that takes public companies private because in their own words...it is easier to run a company away from the public markets...but yet, they in turn went public. Why? Because they are not idiots. The idiots are the ones who bought up their stock at the top of a cycle. Here is the next problem. No one...and I mean no one...wants to buy any more of this debt because they "jumped the shark!" Yes...when Blackstone went public, it became easy for investors to recognize what was going on. There is now in the neighborhood of $300 billion worth of deals that need to be funded. This past week, we have found out that Chrysler and a few others cannot get done. All this supply has crushed the high yield bond market sending rates higher and prices lower...which in turn makes things even tougher. I hope it doesn't but this has the makings of one gigantic blow up. I believe there is a lot of Xanax going around...and believe that sooner rather than later, we are all going to wake up to a couple of these deals cancelled...and then all heck breaks loose. This is again another case of greed run amok by people that did not have to be greedy. As Bud Fox asked Gordon Gekko:"How much is enough?"

3) Another potential problem that no one is talking about is that THIS Democratic leadership wants to raise every tax under the sun. They love your money. I am of the opinion that unless Iraq has the biggest of all turnarounds, Republicans have no chance in the next election no matter who runs. Republicans are a horror show also...but at least they want to keep taxes low. I must make note that the Dems just do not want to raise income taxes, they want to raise corporate taxes, dividend taxes, sin taxes and anything they can get their hands on. THESE Democrats believe power should be centralized IN THEIR HANDS and not in yours. They do not want to wait for the election. They have already moved to change procedures in order to make it easier for all this to occur. Whether you are a Republican or Democrat, you had better wake up to this...because once they start, they will not stop. Don't think for a second that markets are not watching this. In fact:

John Edwards said that if elected President, he would raise taxes for "wealthier" Americans and funnel "some" of the money to low-income families. Notice the word "some." Edwards would raise taxes for families earning more than $200,000 a year and increase the tax on capital gains investment profits from 15 percent to 28 percent. Why do people like John Edwards hate success? Why do they continue to get things ass backwards? 35% Federal tax is NOT enough? This hypocrite of the first order doesn't have the first inkling about what works or what doesn't. I wouldn't let him run my kid's lemonade stand. I say he should take over for Castro. Cuba is more suited for him. Here are the facts.

The top 25% of income earners already pay almost 85% of all income taxes.

The top 50% pay almost 97% of all taxes.

The top 1% pay almost 37% of all taxes.

What more does this dimbulb want?

4) Lastly...we must talk about housing. Whenever you see 500 people line up to buy condos in hopes of selling it 3 days later at a profit, you are getting close to a top. Whenever you see websites teaching you how to flip condos and houses, you are getting close to a top. Whenever you see a college teaching you how to flip condos and houses, it is getting close to a top. We all saw this happening firsthand. This was clear and concise evidence that emotions and greed had bubbled over the top. It was just a matter of time. I could go on and on...but it was a gimmee. The other gimmee is all these calls on a weekly basis of a housing bottom. Since day 1, I have stated that bearish cycles in housing do not end in weeks or months...but in years. What we are seeing is classic. We are seeing a huge inventory build because of how high prices went. We are seeing a huge inventory build because of all the speculation. That is now gone. We are seeing a huge inventory build because of the overbuilding at the end of the cycle. It does not have to end in a crash. I just believe we are now in a buyer's market that has a long way to go. Miami is still in the midst of building another 20,000 condos in the face of a 50% drop in sales. This will all need to worked off...and that will take time...and unfortunately, will take price declines. Hopefully, it does not end in something nasty. I do believe we will see more than one publicly traded homebuilder file bankruptcy during this downturn.

The amazing thing about the week's action was the reaction. Most thought the poor action just started on Thursday. The poor action has been going on for weeks despite the DOW hitting 14,000. I had outlined this to you in previous reports. As I told you, the market was getting thinner and thinner...new lows were expanding markedly while new highs were contractiong...small caps and mid caps were breaking down...and the average stock was getting klonked. On top of that, FINANCIALS were acting like they were going out of business. This past week was simple. The popular indices just played catch-up to what was already going on underneath the surface.

I do have a few predictions. First, I think you are going to see all the minions out in force...telling you everything is ok. Paulson was out again Thursday and Friday saying subprime is not a problem. This man is turning into a classic case of the "boy who cried wolf." If he keeps this up, there will come a point where the market turns a deaf ear. Secondly, with any more ugly, I expect Gentle Ben to throw in a rate cut as Gentle Ben does not want the market to go down. Third, expect the New York Times to blame everything on George Bush. Of course, according to the New York Times, George Bush caused the bubonic plague.

Now what? I would be about as defensive as defensive could be. Markets are short term oversold and extended to the downside but if we are indeed in some trouble here, oversold can get more oversold. All I know is that too many stocks and sectors have topped...and I don't think they have a chance to just turn around in the near-term. All short-term support levels have been broken and in the RUSSELL 2000's case, it is now below the longer term 200 day average...and that is not good. In a previous report, I alerted you to own the TWM...the double inverse of the RUSSELL as I thought it was the weakest of the major indices.

We are already hearing the same stuff we always here when the market drops for even a day. We are hearing: "Cheap"..."Overdone"..."Hiccup"..."Economy is fine"..."Fundamentals do not support a drop"..."Buy any drop"..."Market is a gift"..."Great value" I just find it amazing that not one of these permabulls ever even considers a correction possible...let alone something worse. I dont know if we crash...but it could happen. I don't know if we slow bleed...but that could happen. I will just keep a defensive posture until the market decides otherwise. How will I know? I will be looking for a follow through day to change the trend back to a confirmed rally.