Immediately after I sold the Euro short around $1.29 against the dollar a month ago, I got the immediate gratification that I usually expect from these sorts of trades, the beleaguered currency dropping to $1.26. That took the leveraged short Euro ETF (EUO) up nicely from my cost at $20.73 to $21.30, generating a profit of 0.70%. I then made the mistake of not taking the money and running.

Since then, the Euro has rallied six cents against the greenback, taking it as high as $1.3220, which is quite a large move in the foreign exchange markets. We went through my $19.50 stop for the (EUO) once a week ago, but I doubted its sincerity and held off pulling the trigger.

When I saw the Euro taking a second run at the highs in Singapore last night, I decided to get a second opinion. I dusted off my antiquated High German, which I learned in Berlin in the 1960’s, and called an old friend at the European Central Bank headquarters in Frankfurt to get his read.

The ECB is meeting next week to decide if they will cut interest rates. The case for a 25 basis point cut is overwhelming, based purely on economic fundamentals. But no one ever got rich underestimating the stupidity of European central bankers, who seem to be using a dog-eared and heavily worn playbook they pilfered from Ben Bernanke.

So it is a coin toss whether we will see lower rates next week or not. If they do cut rates the Euro will fall back down to the 2012 lows at $1.26, and maybe more. If they don’t, then it could rally as high as $1.35. Absolutely nobody is buying the Euro here. The entire recent move was caused by short covering alone. Yet, the total size of the market short has risen to another all-time high. The CME is showing 170,000 contracts short, worth $17 billion. That is not counting shorts in the interbank market, which could be far larger.

I am reminded of that old quote from baseball legend, Yogi Berra: “Nobody ever goes there anymore because it’s too crowded”. With shorts this large, it would be easy to see a squeeze continuing. The Euro got a nice tailwind from the global “RISK ON” rally that commenced this year. Modest progress on the Greek debt negotiations provided a further assist. A stealth QE3 from Europe provided even more juice.

I am not in the business of making 50:50 bets. I much prefer 80:20 bets or 90:10 bets in my favor. I don’t want to get into a position where many hedge funds found themselves for the first four months of last year, fighting their Euro shorts tooth and nail, while the European fundamentals were rolling over like the Bismarck. When the risk/reward changes, I change. So it’s auf wiedersehen baby for the (EUO). My total loss on the position is a modest 1.56%, which works out to $1,560 dollars for my notional $100,000 portfolio. I’ll live.

It could be that I just stopped out at the top of the entire move. That happens with stops sometimes. If that is the case, get over it. If you can’t stand the heat, get out of the kitchen. Maybe you should consider another line of work. I understand there are wonderful opportunities in mining in western Australia, and there certainly is a shortage of computer programmers here in Silicon Valley.

The smart play here is to let a squeeze continue on up to $1.35, and then re-enter, not through the (EUO), but through put options on the (FXY). That would give you much more bang per buck at a better entry point, in a better risk limiting instrument, with a much better risk reward ratio.

On to the next trade.

At Brandenburg Gate 45 Years Ago

The Southwest, Florida, and Detroit were the hardest hit markets. The real shocker is Atlanta, which delivered the greatest loss, down 11.9% year on year. Market conditions there are the worst since General Sherman’s Yankees burned the city in 1864. The grim procession that followed included Las Vegas at -9.4%, Seattle at -6.3%, Chicago at -5.9%, and Los Angeles at -5.4%.

I called a subscriber I knew in the real estate business in Atlanta to find out what the hell was going on. He told me that much of the weakness was happening at the low end of the market that was financed with five year balloon payments. When they come due they can’t be rolled over, so homes with negative equity are being dumped into a black hole where there are no buyers.

My expectation is that house prices have another 25% to go before we reach a final bottom. Of course, such comments invite truckloads of abuse from the real estate industry, which has been insisting that a recover is just around the corner for at least five years now. Let me list off everything that will go wrong with real estate over the next two years:

• 80 million baby boomers are attempting to sell their homes to 65 million Gen Xer’s who make a lot less money than their parents did. Don’t plan on selling your house to your kids, especially if they are still living rent free in the basement.
• Fannie Mae and Freddie Mac, which are currently refinancing 95% of US home mortgages, are in receivership. Having wiped out their capital in the housing crash, they are unlikely to get refunded by congress. A wholly privatized home loan market is likely to raise borrowing costs by 200 basis points, as it already does in the non-conforming jumbo market.

Things Are Not Well in Atlanta

• Get ready to say goodbye to that home mortgage deduction as part of any budget balancing effort in Washington. This government subsidy, worth $13,000 per homeowner with a mortgage less than $1 million, is costing the government $250 billion in tax revenues annually. Any flat tax proposal does the same thing. How long should renters continue to subsidize homeowners? It’s been going on for 75 years.
• Ben Bernanke’s “twist” program has dramatically flattened the positive yield curve, preventing banks from recapitalizing themselves with the shrunken positive carry. This is what bank share prices have been telling us with their horrific performance, with lead stock Bank of America (BAC) plunging from $14 to $5 in just six months. Translation: fewer bank loans for you and I mean lower house prices.
• Look at the chart of November Case-Shiller data below. Despite the greatest real estate stimulus in history, prices have flat lined in for two years and are starting to roll over once again. The 30 year mortgage is under 4%, a 60 year low, and affordability is at a 60 year high. Until last year, buyers in California were getting a combined state and federal tax breaks of $18,000 to buy a house. What happens when the stimulus ends?
• According to the Federal Reserve, 35% of US homes have less than 10% equity or negative equity. That means that 42 million homeowners will have nothing left after a sale, including closing costs. We now have negative equity states, like Nevada and Arizona. People are trapped in their homes, and can’t move to accept new jobs elsewhere.
• To say there is an inventory overhang would be a huge understatement. There are 1 million new homes and 5 million existing homes now on the market. According to Zillow.com, another 10% of homeowners, or 15 million, would sell on any improvement in prices.
• Add up all the above, and of a total market in the US of 150 million homes, there are 21 million homes for sale, and 42 million buyers shut out of the market.
• Has anyone heard there might be a recession later this year? That’s what the Congressional Budget Office is forecasting. What little buying that is going on has to dry up. The expanded U-6 unemployment rate, including “discouraged” workers and those with expired benefits, is likely to soar from the current 16% to 25% to match Great Depression highs.
• After the 1929 stock market crash, home prices took 25 years to recover pre-crash levels. I think that we are seeing a repeat of this phenomenon, with 2006 as the start date. Get ready to cash in on the new bull market in real estate in 2031, when newly enriched Millennials start to join the fray in large numbers.

With all that said, I am still looking for a home to buy. That will most likely occur on a courthouse’s steps, where cash is king. Why not, if I can get the 2020 price now, down 50% from today’s level? Until then, I will happily rent, not buy.

The Worst Market Conditions Since 1864?

Look at it this way. That is $100 billion that gets sucked out of the market. It is $100 billion that gets diverted away from existing equity allocations. Many investors will need to sell existing positions in other companies to pay for their new Facebook shares, especially in the technology sector.

Can the market afford to lose $100 billion in buying power in its current fragile condition? I think not. Take a look at the chart below which has the (SPY) making a near parabolic move since the beginning of the year. At the very least, we need to pull back to just above $126, which takes us down to 1,256 on the S&P 500, smack dab on the 200 day moving average. If you don’t believe me, then take a look at the chart for the financials sector ETF (XLF), which has led the market this year and is clearly rolling over.

I’ll tell you who the big winner in a Facebook IPOP will be. The San Francisco Bay area. $100 billion is a ton of money to pour into a single urban area. The issue is expected to create several billionaires and as many as 3,000 new millionaires in my neighborhood.

The last time that happened was when Google (GOOG) went public, creating a wealth effect that never went away, taking the waiting list for a new Ferrari or Tesla out two years. Better buy real estate near Facebook’s Menlo Park headquarters, such as in Atherton, Palo Alto, and Mountain View. The bidding wars are about to begin!

Is Mark a Market Killer?

What is even more amazing is that its cash position now sits at $97.6 billion, greater than the GDP of all but a handful of countries. In the midst of the current political debate, it is fascinating to note that the greatest capitalist enterprise in history was created by a vegan hippy college dropout from California who took LSD, walked around barefoot, and never took a bath.

Watching Apple (AAPL) post a new all-time high of $457 today, I was struck by a wave of nostalgia. When I took a young, cocky, long haired, Levis wearing Steve Jobs around to meet Morgan Stanley’s institutional investors to pitch an Apple secondary share offering 28 years ago, I vowed never to buy anything from the man. He was such a great salesman, and possessed such a messianic devotion to his product, the risk of getting legged over had to be great.

This proved a good strategy for the next 18 years, when the company nearly went under three times, and the stock repeatedly plunged from its initial listing price of $22 down to $4. Disastrous products like the Lisa came and went, and then poor Steve got fired by a man he hired, John Sculley. Ouch!

Living in the San Francisco Bay Area, I was also creeped out by the fanatical cult following that Steve enjoyed. Criticize an Apple product here, and you risk getting attacked, ostracized, deleted from address books, chopped off Christmas card lists, banned from Facebook pages, and ejected from Twitter accounts. There was also no end of abuse from my IPod, IMac, and Tablet addicted kids who accused me of being a dinosaur sticking with my wheezing and spam infected Windows based PC.

I have to confess now that my prior prejudices led me to miss the boat on Apple for the last decade, when the stock soared 115 times. To see the company sell 37 million IPhones in a single quarter during unstable economic conditions is nothing less than amazing. While Main Streets around America sit empty, the Apple stores are easily identifiable because they are packed like a New York subway car at rush hour.

Forecasts for the global smart phone market are ratcheting up by the day on the back of surging demand from emerging markets. Sales could reach 250 million units annually by 2012, of which 17% currently is sold by Apple. China Mobile, with a staggering 600 million mainland customers, or six times Verizon’s, is now considering adopting the IPhone.

The company has become a monster cash flow generator. Apple now has the envious problem in that sales of several of its products are going hyperbolic at the same time.

Apple announced net profits of $13.06 billion, or $13.87 per share, up 11% from the previous year. If the company just maintains that rate for the rest of the year, it will generate $55.48 in earnings, which at the current 11.5 multiple should take the stock up to $638, up 40%. If Apple makes it up to a market multiple, the stock should rise to $721, a gain from here of 58%.

If the multiple expands to its pre-crash average of 35 X, that would take the stock to a positively nose bleeding $1,941, giving you a 424% return from current levels. Then the company would be worth $2.8 trillion and rank 5th in the world in GDP, more than France, and just behind Germany. Wow!

It all reinforces my view that Apple shares will reach my long term target of $1,000 sooner than anyone thinks. Long term readers are well aware that I have been making this call for the past two years back when it was trading at a lowly $240. More recent subscribers will also recall that I predicted that Apple would be the top performing technology stock in my 2012 Annual Asset Class Review.

I’m not saying that you should rush out and load up on stock today. But it might be worth taking a stake on the next wave of fear that strikes the market.

So far, the company has resisted every entreaty to part with some of this dosh, either through a share buyback or a dividend. Now some are speculating that the passing of founder, Steve Jobs, and the succession of new CEO, Tim Cook, could lead to a loosening of the purse strings.

Let’s face it. Apple has had a great, decade long run. Hundreds of my readers, many of them Apple employees, are faced with the enviable problem that, having ridden the stock up from $4 to $457, they have too much of their wealth concentrated in a single asset. That is never a good idea from a risk control point of view. But every time I look for reasons to sell Apple, I find three more reasons to buy it. It’s a case of the grass being greener on my side of the fence.

Let me list just a few avenues for continued meteoric performance:

• As the Apple generation reaches the ranks of senior management, more Fortune 500 companies will begin to support their products. Thousands would love to quit carrying around a Blackberry for business and an incompatible IPhone for personal use, with the associated chargers. (note to self: short (RIMM) on the next rally).
• Despite this torrid growth, the stock trades at 11.5 times earnings a discount to the S&P 500 at 13 times earnings.
• The Apple of today is essentially a spanking brand new, high growth company. The company’s only decrepit product is the IMac. The IPhone is only 5-6 years old, while the Ipad and Ap Store are only 1-2 years old and still in their infancy. The potential near term growth of these products is huge.
• IPhones only have a 5% penetration of the world market. Past market leaders like Nokia (NOK) and Motorola (MOT) have reached market shares well into double digits.
• Apple has just scratched the surface in China, where it only has six official stores (but lots of fake imitators), and is already the premium product. The growth opportunities there are massive. Everyone there wants an IPhone, and they are traveling to Hong Kong to get them. When the Beijing store was unable to open due to the crush of customers waiting to buy the new IPhone 4s, it was pelted with eggs.
• There was always a fear of what would happen to Apple stock after Steve Jobs was gone. That is now behind us. In the wine bars around the company’s futuristic Cupertino, California headquarters at One Infinite Loop, I am hearing that Steve left behind enough new product ideas, improvements, upgrades, and direction to keep Apple forging ahead for another five years. The vast, interlocking, synergistic ecosystem he envisioned is still maturing.

I follow dozens of fundamental and trading research services and the number that are flashing warning lights right now is close to an all-time high. For example, the AAII sentiment survey now shows that 46% of investors believe that the stock market will be high in six months, well above the 39% historic average. It has only been higher than this 11% of the time since 1990. The put/call ratio has collapsed, indicating that traders no longer see the need for expensive downside protection. It has not been this low since 1998.

A number of surprises have conspired to create this warm and fuzzy feeling. The ECB has engineered a stealth quantitative easing that is helping support asset prices worldwide, as the Federal Reserve did a year ago. The recent spate of European bond auctions has gone well. China surprised many (but not me) with a Q4 GDP of 8.9%.

It is not unusual to see a strong January, which is the most bullish month of the year by a large margin. Since 1928, the average January gain has been 1.69%, compared to 0.51% for all other months. As of this writing, we are up 4.8% month to date and it is definitely appearing overcooked. With the (SPX) up 22.8% in less than four months, it is normal to see data as sizzling as these. The last time traders were this positive was back in April, just ahead of a 25% swoon.

I think we are seeing the same “benefit of the doubt” market that we saw 12 months ago. Many of the most conservatively run institutions, like pension funds, only change asset allocations once a year, usually in January. With the ten year Treasury bond yielding a pitiful 1.80% at the end of 2011, it forced a natural one time only reweighting out of bonds and into stocks. Much of that new money for stocks gets spent in January.

In additional, with S&P multiples at 12.3, close to a historic lows, many institutions are willing to raise market weightings from underweight to neutral. If the economy improves they will add to positions. If it doesn’t, they will dump what they just bought. I am betting on the latter.

I am looking to see how I could be wrong in this assertion and I am hard pressed to find out how. This morning, the International Monetary Fund predicted that a Europe falling into recession could chop as much as 2% off of world economic growth this year. Is there any way they can avoid a recession? Not with long term interest rates at 6%-14%, the ECB engineering a slow motion decline in short term rates, and the interbank lending rates in a catatonic state. And that is ignoring Greek bond rates at 35%.

Will China’s economy suddenly rebound to double digit growth rates once again? Not if Beijing has anything to say about it, which has been pouring cold water on the economy to extinguish the inflationary fires.

Calling the top in these speculative mini bubbles is always an impossible exercise. But it is safe to say that we are far closer to the top of this move than the bottom, and the next trade alert is far more likely to be a sell than a buy. If you don’t believe me, then take a look at the Elliot wave analysis by my friends at stockcharts.com. It predicts an (SPX) top on this move of 1345 to be followed by a sell off to the trendline at 1,280 at the least, to a complete breakdown of the move at the worst.

The Alarm Bells Are Ringing

Why should you care? Because countries with high savings rates tend to have strong economies and great stock markets, since there is plenty of excess cash available to pour into investments. Those with low savings rates suffer from weak economies and poor stock markets, because of a shortage of available capital. When the American savings rate dropped below zero in the latter part of the last decade, it set off emergency alarms for me that a collapse of the financial markets was on the horizon.

During the last four decades, I have watched Japan’s savings rates plunge from 16% to 2.8%, and you know the result for markets there. When it approaches zero, that will be the time to short the JGB’s, the yen, and the Nikkei stock index. The only country that doesn’t fit this analysis is Australia, with a mere 2.5% savings rate, but boasts a positively virile stock market and currency. The resource boom there is skewing things towards under saving and over consumption.

By the way, the outlook for the US, with its still miserable 3.9% savings rate, does not look great when considering this benchmark. Don’t expect a runaway bull market anywhere savings rates are low and falling. What are savings rates telling us are the best countries in which to invest? China, 38%, India, 34.7%, and Turkey, 19.5%.

• Australia 2.5%
• Japan 2.8%
• USA 3.9%
• Brazil 6.8%
• Britain 7.0%
• Germany 11.7%
• Ireland 12.3%
• Switzerland 14.3%
• Turkey 19.5%
• India 34.7%
• China 38%