Mon, 10/06/08 04:01:45AM FROM: High-Tech Strategist TO: 8. NICHOLAS WALKER THE HIGH-TECH STRATEGIST Tssne #251 October 5, 2008, Published Monthly Since 1987 Editor: Fred Hickey DILA 1325.38 NASDAQ 1947.39 A September to Remember In last month's lottr - “t's the Most Wonderful Time of the Year,” I propoved that the stock market was ripe for disaster as we headed into the two most dangerous months of the year historically ~ September and October. I ended the leer as follows: “There's been a mood change from complete vomplacency to a bit of uncase. Hopefully, that tuncase will tur into fear, then gripping fas, panic and finally, total capitulation. I've been pationtly waiting a Yong, time for this, but this is the time of year when capitulation can happen!” Its fair fo say that no one was more prepared for what has just occurred over the past few weeks than I, yet oven I am amazed at how quickly the financial world hes tume< upside down. Ina little more than four weeks, the unease did tum into feat, gripping fear and panic. The only part missing now is tolal capitulation, While September is historically the worst month of tho year, October is famous for its crashes, minisrashes and market bottoms (1929, 1974, 1987, 1997, and 2002). On Friday, afer the passage of the $700 billion’ financial rescue plan (the plus is for the additional $100 billion of pork thrown in to get the measure passed), a 314 point market rally evaporatcd, fuming into a 137 point decline by tho close. The Dow Jones Industrials lost 471 points in leas than thee hours. It ‘was an extremely ominous response to the “good news” thatthe bulls on Wall Stiect had been anxiously awaiting, Over this weekend, two major European financial bailouts have unraveled, Hypo Real Estate, Germany's second largest propatty lendet, indicated that last week's agreed upon bail out plan (35 billion curos, $49 billion) was insufficient. Gorman nowspaper Dic, Welt reported that Hypo will necd 20 billion euros in financing by tho end of next week, 50 billion euros by the end of the year and up to 100 billion euros by the end of 2009, Commercial banks involved in the original bailout plan have withdravm their support. The German government is scrambling this weekend. If that wasn't enough for the European markets to worry about, Belgium this weekend is attempting to deal with last week's bailout of Forts that has gone awry. In the original (eptember 28) plan, Belgium, Luxembourg and the Netherlands had agreed to inject over 11 billion cures into Fosts. Given all ofthese developments, Lam on “High Crash Aleit” as I yite this letter. Another October capitulation moment may be imminently upon us. While I'm glad to be in “maximum defensive positon,” I can’t say I'm happy that we've come to this. There will be a Jot of people hurt as the result of our govemments’ failures over the last several years ‘To me, this outcome was all so predictable, I've been waming about this “day of reckoning” for years, The following passage is fiom newsletter #204, in November 2004, nearly four years ago: ‘The section was titled “Breaking the Curse ofthe Greensbeamo”: To some, it appears that Chairman Greenspan's goal of perpetual US. prosparity has been nearly met (there hhasn’t been a decline in consumer spending in 14 years) and he is revered by many. Unbeknownst to the many, however, are innumerable unintended consequences that were created as a byproduct of the goverament’s interventions. ‘One ofthe unintended consequences was the giant tech overcapacity bubble of the lato-1990s. According to Federal Reserve data, from 1996-2000 increases in tech capacity ran at @ 35% to 45% annual compounded rate of growth. Over that same period, 441 new publicly held tech Companies were created in the U.S. Ih 2000, venture capital investments reached $103 billion, up nearty 20 times from the level a decade earlier. The result was too many Internet companies chasing “eyeballs,” too mich semiconductor manufacturing capacity, too many fiber: optic lines, t00 many computer hosting sites, too much of everything tech. Though the tech stock bubble crashed in 2060-2002, the capacity overhang continues to plague the industry. Nevertheless, the Fed's reaction to the stock market bust was to drive interest rates to 1% and rapidly «grow the money supply further. The resulting money and credit binge led to a new bubble m housing. House prices have soared far in excess of personal income growth. For example, in California, fewer than one in five households can now afford to buy the median priced home - $464,000 - up over 20% year- ‘over-year. There seems to Be no need to save inthe land of | perpetual prosperity, and with interest rates sa low, US.Mon, 10/06/08 04:01:45AM FROM: High-Tech Strategist TO: citizens save nothing (the U.S. personal savings rate in Q3 2004 dropped to a record-low quarterly rate of 04% of, disposable income, and lower still in the month of September - to 0.2). The US. government doesn’t care much about saving. either, with a record fiscal year 2004 budget deficit of $413 billion. The day after this week's national election, The Treasury Depariment formally requested that Congress raise the nation’s $7384 trillion debt ceiling by another $700 billion or 80, the third such request in three years Thanks to the generosity of the Fed, vith money and credit s0 easily available, consumers have racked up ‘gargantuan debt levels. Household sector debt 1s nearly $9.7 illion, up 10% over last year. As the country binges ‘on homes and SUVs and digital entertainment products at Best Buy (all on credit, the US. trade deficit soars. ‘Again, that was four years ago. Over that period, the situation has only worsened, as the poptlation "was encouraged to continue fo binge on homes and SUVs and entertainment prodvets. The latest Flow of Funds report issued by the Fed last month shoves that tolal houschold sector debt is now $13.2 trillion, up another 36% The national debt eciling was jst raised again to $11.3 trillion, It was the seventh increase since President Bush took office in 2001 {at $5.95 trillion. In 2004 the budget deficit vas $413 billion. The budget deficit for the month of ‘August 2008 was $112 billion, following a $103 billion deficit in July. Thanks to the sinking economy, federal goverment receipts fell 5.7% year-over-year in August Meanuibile, outlays soar (up 7% year-over-year for the first 11 months of fiscal 2008). With the passage ofthis “rescuo” plan and the economy sinking, the budget deficit in fiscal 2009 will likely exceed $1 trillion. Will we be ablo to borrow such sums from our traditional lenders - tho Chinese, Japanese and Middle Easter counties? Some are already balking. They are up to their eyeballs with our debt, In my January 2005 neyaletter (206), sostion titled “Desperation and the Dangers of Debi,” observed: The IBD (Investor's Business Daily) editorial tried to discredit concern over the US. record “twin deficits” (trade and budget) by noting that, “one, the other or both have been ont of whack for years.” Here again, the loomies ‘are whistling pas the graveyard. I'll not just use relatively recent history here, Throughout time, thoughifl men have Been resolute on the ‘dangers of too much debt (particularly government debi). The Roman orator and Statesman, Cicero had this to say in 63 BC: "The national budget must be balanced The public debt nnust be reduced; the arrogance of the authorities must be moderated and controlled. Payments to foreign governments must be reduced, if Rome doesn't want to become bankrupt.” A founding father and one of our greatest presidents, ‘Thomas Jefferson, made these statemenis regarding debt “I place economy among the first and mast important 5. NICHOLAS WALKER virtues, and public debt ax the greatest of dangers to be feared.” To preserve our independence we mist not let ‘our rulers load us with perpetual debt... We must make our choice between economy and liberty or profusion and servitude.” ‘Need Cash, Want a Vacation? "Thanks to easy money policies at first, and then the ncar-climination of lending standards later, homes prices in California (and around the country) continued to soa. Home prices were way too high whon I wrote that November 2004 letter, but three. years later they were sidiouloos. According to the Califomia Association of Realtors, the median price of existing homes was $588,670 in August 2007, In August 2008, it’s now $350,140 — a sickening fall of 40.5%. The resulting collepss in home equity values is what has destroyed the likes of giant mortgage Iendors Washington Mutual and) Wachovia Homeowners (and bankers) counted! on evertsing home prices to sustain the ever-rising levels of debts, According to the latest Case-Shiller index, U.S, house prices fell nationwide by a rocord 16.3% in July. Per the ‘Commerce Department, new home construction dropped to a T7-year low in August, to an 895,000 annual rate. At the peak in carly 2006, that rate was 2.3 million. New home sales in August also dropped to a 17-year low. Morigage delinquency rates arc soaring. ‘The latest survey from the ‘Mortgage Bankers Aswociation (MBA) found that 9.16% of mortgages for one-to four-fumily homes were at least a month overdue or in the foreclosure process at the end of the second quarter, up fm 6.52% a year earlier and the highest level on record (a least 39 years), ‘The US. housing market collapsed because prices got way out of line with incomes and rents. The historical relationship of house prices to incomes and rents was distorted by casy money, lowered londing standards, fraud and greed. ‘The goverment stood by and watched as the disastrous misbehavior proceeded. According to the MBA, among, loans insured by the FHA, 14.87% were overdue or in foreclosure, Nevertheless, just last month I heard a radio ad fiom a mortgage broker pushing “no money down Jans” backed by the Federal Housing Administration. The bwoker’s sales pitch was: “Need cash? Want a vacation?” Despite all that’s happened to date, the U.S. government is still encouraging bad lending. Whon will the FHA need bailing out? | started waming about signs of trouble in the housing market in July 2005 (issuc#!212). From the section titled "Slowdown Signs”: Interestingly, the nationwide inventory of existing homes in May has risen by 398,000 18.596) since January to 2,545,000 units (editors note: the inventory is now 4.3 nillion in August 2008). Because the sales activity rate is stl] high Qlipping), the calculation of months of supply (4.3 months) is considered normal (editors note: the inventory is now 10.4 months). However, we know that before this house price bubble collapses, there will first be @ buildup of inventory, as buyers hesitate and greedyMon, 10/06/08 04:01:454M FROM: High-Tech Strategist TO sellers hold out, We may be seeing the first signs of that standoff Locally here in Nashua, the tone of the real estate market has definitely changed. Less than a year ago, hhouses inthis red-hot market were usually snapped up ina matter of days (including the house right across the sree) T walk a four-mile loop around my neighborhood nearly every day (as I fight the mid-life battle ofthe bulge). Two ‘months ago, there were six houses forsale on the route. As of today, not a single one has sold, and two others have joined them. This market (upper middle-end by Nashuacity ‘standards) appears to have stalled out. Intrigued, I've been checking the property listings in the Sunday local newspaper. Yesterday, a very large manber (16) had the notation “price reduced.” Nasinia is just over the Massachusetts border. The Massachusetts Association of Reaitors reported last week an 11.19 year-over-year decline of May sales of singe- family homes, following a 10.4% fall-off in April. It was the lowest number of sales inMay since 2001. The number of unsold, single fermily homes on the market in the Greater Boston area was at the highest level since data has been kept (eight years) by the MLS Property Network According to MES, nearly 4,700 homes were for sale, a 25% year-over-year increase, The Massachusetts realestate market had been one of the hottest (and mast expensive) markets in the county. Prices had risen more than 50% over a recent three year period. Though median home prices aren’t yet falling, they ‘were only up 6.2% in May (to $359,900). Home prices in the first quarter were growing at « 12% year-over-year clip. According to data from Foreclosuresitass Corp, the umber of mortgage foreclosures in Massacinssetts in the ist four manths of 2005 has jumped 27.8% to 3,740. Fram the Boston Globe: "When you tie all these ‘factors together ~ the bubble inthe rea estate market, the ‘porrularity of interest-only loans, the willingness of lenders to give loans without a significant down payment, the lowering of standards for lenders, and the deep desire of ‘people to own something priced beyond their means --yot have a recipe for disaster,” said Massachusetts Secretary of State William F. Galvin, whose office oversees the registries of deeds in a majority ofthe state's 14 counties. "That's what you're seeing in the Land Court.” While one can't assume that local real estate conditions are indicative of what ts happening nationally, tone shouldn't dismiss these closevat-hand observations. The New HampshireMassackusetts area has been a primary participant in the realestate bubble. This is not Peoria. While the national data is only now hinting of the slowdown apparent here, remember thatthe national data is reported with a lag. Because of the time required to clase ona house, existing home sales reflect activity thats ‘one to two months old. Therefore, the latest national existing home sales numbers reflect purchases made tn March or Apri of this year. The stalled market locally is ‘based upon my up-to-the-minute observations. S. NICHOLAS WALKER The Wall Street Journal last month reported that Chicago's condo market (hird largest in the nation) was cooling as supply increases, Hans Norby, from real estate research frm Property & Por(folio Research Inc. told the Journal, “We're seeing in the last couple of months the sound of the bubble breaking in the Chicago central dusiness district.” “Projects are starting not to sell, theyre starting to goto the bank. The bubble ssterting to break.” While 'mstill getting reports of sane California and Florida realestate sales, its typical at tops forthe market to miss the broader picture. Change has Begun, as we know it had to, Eventually, proof that the get-rich-quick real estate game is over will reach the wildest outposts in California and Frida. That's when the mainstream press ‘will take more notice. Again, the warning signs were there forall to see. Yet everyone seemed to be Dlind to them. Almost a year later, in my April 2006 newsletter (#221), titled: “What I Did On My Winter Vacation,” I described the glut of poorly- constricted, single-family residences and condos that I saw on my 3,038 mile driving trip to Florida and back in “The Beast,” our 1996 Ford Minivan - with pavticular ‘emphasis on the disastrous situation brewing in Florida, rom the section titled “There's a Bust a Comis 1 have the same feeling about this housing bubble. From my viewpoint, it's cracking wide open and no one seems 100 worried about tt All hear is "Goldifocks” talk ~ the economy ts not too hot and not too cold. It's just right! Once again, I'm incredulous. Don't the bulls tunderstand that it was the creation of the housing bubble that saved the economy from recesston in 2002? All those Jobs created to build and supply and sell and finance the homes helped to offet the millions of manufacturing jobs lost after the crash Sill, the bulls particd well info 2007, ‘The following are segments from newsletter #237, August 2007 titled “Liquidity(s) Have Left the Buildings”: Back in January at the allay Barron's Roundtable session, J became increasingly frustrated with (what 1 ‘perceived as) the cavalier attitude of some ofthe Roundtable ‘menbers towards the gigantic imbalances inthe economy: To my left there was Abby Cohen, Chief US. Investment Strategist at Goldman Sachs, who was “in disagreement vith Fred.” My (haifjoking) response was: ‘I's not surprised.” To my right, there was Art Sambers, Chairman of hedge Jfand Pequot Capital Management, who auestioned: "Where is the bubble? Fam confused," and further stated: “The world ir awash with growth. It is awash with liquidity, and our markets ean clear liquidity better than any others.” My response to Art was: "Assets bubbles are always fun while syeu're going through them The Vulip Bubble was fin. The “Misisinpi Bubble was fun But they always end in tears and disaster: At the June midyear Roundtable update, the tisagroements continued. Art Sanbere was upbeat because of corporate profits and “the wad of money in private equity hands." “It ts absurd, but Ihave learned one thing in if ItMon, 10/06/08 04:01:454M FROM: High-Tech Strategist TO: 4s very important to recognise absurdity, but also very stupid to get in the way of it 1 don’t see the private equity boom abating. If corporate profitability in the US. is OK, the rest of the world is continuing to grow and private-equity deals are driving stock action inthe U.S, the marset could be up about 1086 this year." T had a diffrent outlook: "Ieis a perpendicular market, a manic market, the kind of martet that precedes a crash, and that is what I expect.” I explained: “We have real serious problems. The dollar is deteriorating against almost all ‘currencies. Bond yields are backing up big-time, causing all sorts of ripple effects. Potential leveraged buyouts might not ‘get done. Huge pyramids of leverage could start to implode. ‘The back-up in rates comes at a tine when the U.S. consumer has finally had i" Nom, Abby and Art are likeable people, Ably is a swvetheart and Art is quite genial They are exiremely suecesyiul and weelthy New Yorkers. I'm from Cow Hampshire — which might as well bea planet away from New York and nowhere near as wealthy and swoceseful Honever, my primary differences with them are those of ‘opinton. I just don’t see the world the way they do. So far, the stock market cays that they've right and I'm wrong. The Dow Jones Industrials are up 5.8% year-to-date andl the Nascar, Compasite Index is up 49%, Nevertheless, the events of he Tast fow wooks give me reason to believe that my view just might ‘be correct afterall. ‘The giant pyramids of leverage have begun fo topple, one on op of the other, The $12.8 irilion U.S, mortgage markt is in disarray, Much of the subprime and “AltA” mortgage ‘markets (81 tilion in originations last year —one third af all morigages funded) has disappeared According to The Mortgage Lender “Implode-O-Meter,” 109 major US. mortgage lenders have “imploded” since late last year. Liquidity has loft the residential mortgage market. The timing is very bad for ail the borrowers facing adjustable mortgage interest rate resets in the coming months. There's ‘an estimated $800 Dillion of resets coming due over the next ‘year, with the crest of reset activity not occurring until March 2008, A strategist at JP Morgan has estimated that up to 45% of borrowers facing resets wil not be able to refinance In the ‘more restrictive lending climate (and that forecast was made at least two weeks ago). But further home price declines will exacerbate the recent crash in the structured credit markets, euch as the $1 trillion (estimate as of last year) CDO (collateralized debt obligation) market. The collapse in CDO prices has triggered 4 rash of hedge fund and mutual find blow-ups around the world. The list of casualties is long. Two highiy-levered Bear ‘Stearns hedge funds have been shut down (one was levered 1S times) wich nearly 100% losses. A third Bear hedge fund is not allowing redemptions MGIC Investment Corp. and Radian Group acknowledged last week that their $1 billion investment in C-BASS (Credit-Based Asset Servicing and Securitization LLC) could be completely wiped out ‘This was an avcident waiting to happen — and I've heen waiting for it. Extremely easy money conditions, unregulated new financial praduets, huge incentives (hedge find fee S. NICHOLAS WALKER structures) to wildly speculate with other peoples’ money and massive use of leverage was a recipe for disaster. People ‘often borrowed to put money into funds of funds that then levered up many times and then gave the maney to hedge funds who often invested im untested levered financial products. As we've seen, the leverage employed by hedge ‘funds could be 20 t0 1 o higher. An added wrinkle is that ‘some of the borrowing was done in low-interest rao yiolding currencies such as the Japanese yen, introducing ‘complications (currency tosses) as the Great Global Credit Bubble unwinds. That this giant ticking tme bomb woul ‘eventually explode seemed obvious up in here in Cow Hampshire. It was clearly not s0 obvious to many in New York or London. As 1 said at the Barron’s Roundtabe, bubbles are great fun while they last But they always end in tears and disaster. According to the Bank for Intemational Setlamants, there were an estimated $415 trilton of notional value of derivatives coniracts outstanding as of December 2006 (up ‘nearby 4056 year-over-year). Bilionaire Warren Buffet hes called derivatives "financial weapons of mase destriton.” CDO's, CLOs ane credit default saps (CDSs) are prominent ‘ypes of derivatives It appears thatthe fuse om hese financial weapons. has been tit. It is thought that many investors ning derivatives do not brow what they really own, defo ‘he structures’ complete. In some cases. there are diervtives based “on derivatives that are based on dermatves. Counterpartics aren't known, and Yel zome counterparties are going “belly up” in the current carnage. sone royal mes fast like in 2000, I'm witnessing a train wreck in slow motion, yet no one else seems to see it. Investors are exhibiting an incredible complacency about the unwinding of the housing bubble and all the other major threats tothe economy and stock market that are out there: unsustainably high trade deficts, budget deficits, ‘monstrous consumer debt levels, credit defanit derivatives, 4a wobbly US dollar, oil prices near $70, Jrag and Iran, ‘another hurricane season, bird flu... the list goes on and A Hiigh-Spood Crash ‘What was a train wreck in slow motion a year ago became a dizzying, high-speed crash in September 2008, In the first week of September, the U.S. Government was freed to seize mortgage giants Fannie Mac and Freddie ‘Mac. ‘The estimated cost (for starter); $200 billion. Their sive leverage finally ddl them in. The US. added $5 trillion of mortgage and mortgage guarantee debt to its balance shect. ‘The stock market reacted in typical fashion = with a 290 point surge in the Dow Industials. However, unlike the big stock rallies after past govommont sctions the Bush homeowner aid plan in December, emergency rate cut in January, Bear Steams rescue ia March and the short selling squeeze and initial credit increases for Fannie and Freddie in July, this one faded quickly (one day)Mon, 10/06/08 04:01:45AM FROM: High-Tech Strategist TO ‘On Monday September 15, the stock market suffered its worst daily plunge (504 points down on the Dow) sinec the September 2001 terorst attacks. The U.S, government decided to let Lehman fail. Lchman was done in by its more than 25 to [Teverage. Meni Lynch and giant insurer ‘AIG were also in trouble. Merill was similarly loveraged and AIG had derivative exposure of $441 billion. Potential buyers backed away from AIG as tho enormity of its estimated losses grew clearer, Bank of America agreed to acquire Morill Lynch. On Tuesday night tho Fed loaned $85 billion to. AIG at onerons terms. Sharcholder value vwas mostly wiped out. Around the world, bank lending scized up and banks hoatted cash, A $62 billion money- rarket find, The Reserve Primary Fund, “broke the buck” duo to fosses from debt holdings in Lehman. Central banks in the U.S., Europe and Japan each pumped tens of billions of dollars into their banking systems. Stocks had collapsed in Russia, and the {government suspended trading. There was a rush for safety to US. Treasuries and fo gold (the two places whore almost all of my money was already parked). Gold soared more than $100, ils biggost two-day gain in history. The Dow Industrials ell 449 points on Wednesday to nearly a throe-year low. The VIX “fear gauge” spiked above 40 for the fist time sinee 2002, In highly volatile action, the Dow gained nearly all of that back the next day (Thimsday, September 18) on the first reports of the giant govoriment rescue package from the Treasury and rumors of 2 ben_on short scling of financial institutions by the SEC. That short-selling ban fumed out fo be truc, as the SEC soon enacted the ban on nearly $00 financial stocks (and curiously added IBM, GM, Ford, CVS. and others later). The short-selling restrictions were not well thought out and led to lower liquidity and higher market volatility in the following weeks. Stocks surged another 369 points on Friday, It was the Dow's biggest two-day gain since the market battom in October 2002 ‘Tho next week, Washington Mutual, once the nation’s largest thift failed. JP Morgan picked up the picoos (posits and bank braches, but not the debt). Washington Matual’s stock lost 96% of its value in one weck: Wachovia was taken over by Citigroup for a song, though ‘Wells Fargo came in with a contentious higher bid after it became clear the Treasury rescue package would pass ‘Congress. That battle will be settled inthe cours. Last Monday (September 29), the US. House of Representatives rejected the first attempt at passing the ‘Treasury's $700 billion financial reseus plan, ‘The Dow Jones Industrials plummeted 777 points, the biggest point ‘decline in history. The VIX fear gangs ciosod at 46.72, the highest level since records have been kept (since 1990). ‘The Fed poured more than $600 billion into the global financial system. The commercial paper market froze. Even some of the Jargest companies (AT&T and GB) had trouble finding short-term fuming S. NICHOLAS WALKER So that brings us to where we are today. Investors gave the U.S, Treasury rescuc plan a big Bronx checr last week, with the Dow Jones falling 818 points on the week. The ‘overnight lending markets (LIBOR) and commercial paper rarkets are a mess, Hedge finds and mutual funds face forced liquidations as bumed investors pull out. ‘The unraveling of the credit default swaps (CDS - a market totaling $54 trillion) hasn't even begun. The Fannie and Freddie CDS auctions are scheduled to begin this week (Monday, Ostobor 6). The Lehman anction is set for Friday, followed hy Washington Mutual on October 23". ‘There’ are rotting corpses everywhere. ‘These auctions could be disastrous, yet the Treasury’s bailout plan can be of litte hep, as it will take months to implement. Despite the stock market's sharp decline this year to date, the market is sill overvalued. The trailing P/E ratios ‘on the S&P 500 index (21) and Nasag Composite (23) are too high considering the “E” for earnings in the ratios are sare to fall shaply during the inevitable severe global recession we're heading info. Some tech favorites, such as Amazon.com (49 P/E) remain at noscbleed levels. ‘The Dow Industrials are down 22% on the year, the S&P 500 is 25% lower and the Nasdaq Composite has dropped 25.6%. Despite the fact that the epiconter of the housing ‘bubbleveredit collapse isin the US., the U.S. markets are the best performing major stock markets in the world, The ‘European and Japanese markets are dovm over 28% t year, The vaunted “BRIC” countries are fer worse, Brazil’s sock masket has fallen 30%, Russia has plummeted 51%, is down 38% and Chinese stocks have collapsed 57% date. Other than U.S. ‘Treasuries and gold (flat date}, there’s been nowhere to hide anywhere in the world, IPT were a betting man (and am, toa eertain extent) 1'd bet we're heading for a classic October capitlation moment (a four digit decline in the Dow) that will set a short term market bottom that could last for months, ‘The ‘markets are on edge around the world and a big decline could happen as soon as this week. Investors have lost confidences, the hoped-for rescue plan did not allay fea and cvcnts are still spinning out of control. If the markets look like they're truly coming unstuck, we know what the central banks will do. Led by “Helicopter Ben,” ina coordinated move, they'l flood the financial system with more money than the world has ever sen, ‘That way no one country’s currency will stand out for punishment. Interest rates will be slashed around the world. The result could be a temporary relating of asset prices and an explosion in the price af gold (and sovercly depressed gold slocks). Investors can then look forward to tho ond of tno Bush roign andthe likely Obama coronation (wether one likes that outcome or nof, one has to be a realist). An Obsma presidency will bring another huge stimulus package and tax cuts (for some) OF course, borrowing trillions more for band-nids certainly does not solve our unprecedented indebiedness problem, After an expected 1930-style relief rally, (a bigMon, 10/06/08 04:01:45AM FROM: High-Toch Strategist TO: rally began after Fed sharply cut rates post the 1929 erash and lasted until April 1930), we could settle into « more srinding bear market and recession. We'll have trouble funding our massive debt load and interest rates will have to rise to attract capital. The country will be forced to save more, invest more and consume lexs ~ and that’s not bad. The only ther alternative is if the Fed chooses the Weimar Geamany/Zimbebwe hyperinflation option, in which case tho country will ultimately be ruinod. Before we move into the “Strutexy” section of this letter, Pd like to thank the great number of readers who have emailed, written notes and telephoned us over the past few woeks with thcir very kind comments. It is often avery lonely road taking the eontrarian stance, and Tcan’t tell you how rewarding itis to hear how I may have helped subseribers navigate through this historic financial quagmire. Just as T began writing this letter (Friday moming October 3), a subscriber from Michigan left the following phone message: “I just wantod to thank you very much for allowing me to follow your lead in Google and RIMM, I digo with thosc puts and I've never scen anything quite like that in my fife, It was just astounding and I can't got the grin off my face.” “1 just wanted to let you know I was so successful with those RIMM and Google puts that my daughter and son-in-law are now referring to me as Warren Bufoon!” ‘The plunge in RIMM over the past few weeks - my biggest pot option position ~ (134 on 8/22 to 60 on 9729) did lead to some dramatic put gains. For example, I sold some January 2009 puts that Thad purchased for $277 for more than $20 last week. I sold some. short-term September RIMIM put options for over $30 that cost mo $8.72, However, had I held om all the way down on the September puts, T could have sold them for $65, of 17 % times my cos. i suspect that my happy “Warren Buffoon" friend may have done a better job than T of selling the shorter-cam puts. Congratulations! 11 isnot easy fighting the mob. The anelysts following Research in Motion (RIMM) were nearly universally bullish, with many of them having target prices of more than $200. They could not sco what I saw: increasing competition, delayed products, deeriorating ross margins, wild oporating oxponsos and heavy insidor_solling Although all of these waming signs were excruciatingly ‘obvious to me, the bull analysts and investors were blinded by their greed. Most of the analysts slashed their estimates in halE, literally overnight, when RIMM missed quartetiy estimates (for the second ‘quarter in a row!) and sharply ‘guided down estimates for the current quarter when it ‘oportod results on Soptombor 25, Pressures From the Mob ‘A year ago in October I spoke to a gathering of investors in New York sponsored by Barron’s called the “Ast of Successful Investing Conference.” Due to time constraints, I haven't accepted speaking engagements for S. NICHOLAS WALKER some years, but this is Barron's, and they've obviously ‘been very good to me. Just days earlier in October 2007, the stock market had peaked with the Dow Jones Industrials above 14000 and the Nasdaq, Composite over 2800. Ttold the audience that we were in the second most ‘dangerous market for tech investors that I have ever seen in my nearly thirty years of experience. ‘The most dangerous, of course, was the 1999-2000 tech bubble period. When asked by the moderator for tech stocks to bay, [told him I could recommend none at the time. I did give thom list of toch stocks that wore safer places to hides (Microsoft, EMC, Oracle ef) if they had to be invested in ‘the sector, where they might only lose half thoir money, rather than mos of it ‘Evon though the majority ofthe audience was made-up of Barron's readers (Barron's is sometimes detsively refered to as “Bear-on’s by wise-guy bulls), apparently my contrarian positon did not sit well with the crowd that day. ‘The market was flying high and even the Barron's crowd had caveht the fever arlier this_year, with the Door dovm nearly 2,000 points from the October 2007 high and the Nasdaq off nearly 20%, Ireccived a letter from Barron's aking me to participate in this year’s 2008 conference. I would note that the great lan Abelson had nothing to do with this ~ this came from Barron’s management. “We hope you can join ws again this year for the AOST conference..." “We agree with many of your insights about technology stocks and they indeed look good in this year’s market action, However, a lot of respondents to our survey asked that your views be balanced with someone who was more bullish on tech stocks, ‘Toward that end, we would like to make your session more of a back-and-forth with another tech investor, moderated by our Erie Savitz’ So I vas to be the only speaker that was going to be tag-camed by a bullish money manager and a bullish moderator because the erowd, atthe height of the frenzy last year, wanted someone mate bullish. Iwill note thatthe proposed money manager’s fund has lost over one-quarter of its value this year to date (and even more since last October). Thankfully, [had a prior engagoment, so I tured the offer down, ‘This vignette shows just how difficult itis to take the contrarian path against the mob. In 1999 and early 2000 1 ‘vas vilified, taunted and called names, One clown used to leave music messages on my answering machinc, wile colhers would jut yell and seream, Fhave a thick skin (out ‘of nccessity), but I am Incky also to heve such a great numberof supporters who don’t give up on me even wen am too early (often the ease) with my predictions. Over the years, ll the lcttors af encouragement have helped keep my backbone strong in times of duress, Then when things go our way (as they usually eventually do) notes like the following (June 2008) from a subseribcr in Florida sive me great setisetion. “Please tell Mr. Hickcy my firstMon, 10/06/08 04:01:454M FROM: High-Tech Strategist TO quarter put postion paid fora semester at my son's private college.” At the January 2008 Barron’s Roundtable [took a lot of grief from several of the Roundtable members for my “Buy gold, sell horsemen” (RIMM, Apple, Google and Amazon) strategy. I argued that it was not irresponsible to pt a small amount (1% to 2%) of one’s portfolio into put options against the grossly overpriced momentum favorites because eventually the payoffs would be dramatic, I noted that at points in time when stocks are extruordinarily rispriced, such as in 2000, put options make sense even with the’ time decay of premiums, Several of the Roundtable members disagreed. Despite the attacks, [held ry ground, because I knew that the most vociferous of the {group wore the same ones who never saw the disaster from the great tech bubble of 2000 coming. ‘As [took the beating in the mecting, I was looking at the Barron’s Roundtable issue from January 24, 2000 (L brought it with me for support though I didn’t bring it up i the meeting) in which one of the members who was pounding me lad recommended a long list of Internet trash stocks (many of which eventually went to zero and the others all lost_more than 95% of their value (he rocommended Exodus Communications, PSINot, Broadvision, Excite@Home, Cobalt Networks, Gemstar, IDS Uniphase, Critical Path and others). This is what he said in January 2000: ‘T'm recommending all these stocks. 'l give you no numbers Pl give you no prices. am not going to tel you Which ones are going to succeed or fail. [think they are all pretty good companies, and if you bought a package of these stocks over the next three or four years, you would do vory well. Now, [know I can’t gt away with that hoo, 40 Twill sls talk about some stocks. I just want to point out that there is robust change. [hear this stuff all the timo, about how it s a bubble, it’s rdicatons. If you jost usc the ‘numbers to do this staff, No. 1 you won't buy them, which is probably a good thing for some pcople.” knew that we were in a bubble in 2000 and I knew that if onc really looked atthe ridiculous valuations = “the numbers” — a reasonable person would not have bought the crazy tech stocks in 2000, nor woald hehe buy them in 2008, But I decided to take the high road at that meeting and not bring up the sordid past. 'understood that patience was required and that time was on my side. Fortunately, iy subseribers have been patient with me. Again, I thank fully remain in “maximum defensive position,” with most of my portfolio split between short-term U.S ‘Treasury positions and my “huge” precious metals positions, Recently, I took alittle less than a third of my short-term U.S, Treasury postion end switched it into the Rydex CurrencyShares Canadian Dollar Tiust (°XC), The USS. dollar has benefited fiom the rash to safety and short- term ‘Treasury yields have been pushed down to ridiculous levels (nearing 0%). FXC yields about 3.2% with 5. NICHOLAS WALKER dividends paid monthly. Long-term, 1 rather be in Canadian currency. Unlike the US., Canada consistently rung trade surpluses, has had balanced budgets for 11 consecttve years and has actually been paying down debt. Canada is blessed with an abundance of natural resources Gneluding cil). U.S. oil production peaked decades ago. ‘The U.S, Fed is likely to eut rates to 1% or below, which should put pressure on the U.S. dollar once this “slight to safety’ move ebbs Tatil hold tho gold ETF (GLD), physical gold, the gold. stocks: Newmont Mining (NEM), Agnico-Fagle Mines (AEM) and Golden Star Resourees (GSS) and the silver ETF (SLV). My biggest gold position is the gold ETF (GLD). After selling most of my put options in event days, T took the substantial profits and purchased more physical gold and GLD. 1 tumed paper gains into real, ppormanent wealth Considering what it’s been up against, gold’s flat porformanco to date has been outstanding, There have been ‘mass liquidations of commodity pastions by hedge funds and other investors. For example, platinum has planged 59% fom its record high in March and is down 38% year~ to-date, Silver is down 25% in 2008. In Q3, commodity prices posted their biggest quarterly drop in more than SO years, The strength in the U.S, dollar in Q3 also held gold back. The dollar soared 11% ageinst the euro and 12% ‘vers the pound. However, investment demand around the world for gold has rocketed higher in these turbulent times, According to a recent story in the Financial Times, “The shift into. gold coins and bars is so cxtreme that it is ‘causing shortages at refineries around the world.” In just 10 days late last month, the GLD ETP added 141 tons of gold (an inerease of 23%), Demand has been so great for Physical gold that my local dealer can’t got American Fagle or Buffalo gold coins, can’t obtain gold Krugerrands aor silver bars. lean only get Canadian Maple Leats from him. Fortunately the Canadians are remping up thei mints, unlike the US, which has the Eagles and Buffalos on “allocation” (meaning you can’t get them at all). Gold mine produciion continncs to fll year-over year (down 6% in the first half of 2008 per GFMS). Indian imports of gold rebounded sharply in August (op 56% year-over-year) after falling earlier in 2008, European ‘Cecil banks eut their gold sales inthe most recent fiscal year to a 10-year low. Other eontral banks are buying. Because gold mining stocks have been s0 battered this ‘yoar, I purchased some call options on a gold miner's stock index (GDX). It gives me exposure {0 a broad list of Jeading gold mining companics. ‘As noted in last month’s letter, I had tripled my put ‘option positions on tech stocks heading into September to about 3% of my portfolio, Across the board, the gains were extraordinary and T sold most of them off. T currently ‘have put options equal to about 0.3% of my total portfali. ‘The put options positions are: Amazon (AMZN), Qualeamm (QCOM) and Xilinx (XLNX).Mon, 10/06/08 04:01:45AM FROM: High-Tech Strategist TO: actually added to my Amazon put option position Lat last month. It has the potential to take 2 RIMM kind of dive. A retailer with 50 P/E heading into the biggest ceonomic slowdown in decades! Amazon is not scheduled to report until Inter in the month (October 22). Amazon’s two largest markets are the U.S and UK, with heavy exposure fo Furope. ‘The collapse of the euro and pound in 3 versus the dollar should hit Amazon's rezent revenue nd bottom linc contributions from foreign currency gains hard. In addition, there's. the dramatic slowdown in cceonomic activity in al of Amazon’s end markets. ‘The economic slowdown around the world has also taken a toll on cell phone sales, leading to substantia! buildups of inventory. I've heard that the two leading wireless carrier in the US., AT&T and Verizon, have both requested slowdowns’ in shipments from key suppliers, some of whom are important Qualcomm customers (Samsing, for example). The Qualcomm guidance is at risk. Qualcomm is also an institutional fund favorito and therefore will likely be hit by the continuing forced selling ‘The Xiline puts are short-term (with an October expiration date), Both Xilinx and Altera (Xilinx’s primary competitor) report Q3 results in the week of the October option expiration. The Xilinx puts are “free” meaning that T've already taken all my cost (and some profit) out of the position. Scmiconductors acress the board have weakened, ‘Lead times are shrinking and prices for many components aro under pressure. PC sales are rapidly felling (Dell waming last month, cell phone sales are slowing (Nokia ‘warning last month ~ price war). Network equipment sales rales are dropping (Nortel waming last month). When the ‘mannfacturors? sales got hit and. inventors build, the manufacturers just cut off orders to suppliers, such ax semiconductor makers. Virtually all semiconductor makers will have to guide thoir Qt estimates lower. Optimistic camings forecasts for Q4 have to come down in all tech sector. ‘There will bo a blizzard of guide-downs in upcoming weeks. : Bat nono of that will matter if we get the capitulation selling climax that Texpect. For if that happens, I will sell almost all of my remaining pots and plan to go long tech stocks in anticipation of a rally. A capitulation climax should see certain defining, characteristics. Fxpensive stocks that have held up better than others (Amazon, IBM) should get hit hard, Selling volume should explode higher ‘on the panie selling. Into the panic, there should be some sort of reversal that morphs into 2 buying panic, when value investors (like ourselves), who have hoarded their cash for such a moment, jump in. That should lead to & broad, high-volume rally, where more than 90% of the ‘radod shares volume is to the upside (2 90% upside day) Tam making list of potential tech stocks to buy for rally that might last into early next year. Of cours, the stocks will have to fall far enough in the capitulation collapse for me to pull the trigger. Since this is such a dangerous market, and we will certainly be heading into a 5. NICHOLAS WALKER severe, extended recession, companies with high cash flor, clean balance sheets (very litle debt) and high gross margins will be prefered. Microsoft (MSFT) is atthe top of the list, Pd be interested in the very low 20s, EMC is atrctive inthe single digits, Spending on storage ‘equipment should hold up best, even in a recession, EMC's software business has been expanding rapidly and it also ‘owns most of VMware (VMW), the virtualization leader. ‘VMware itself is on my list, Symantec (SYMC), Adobe Systems (ADBE), Sybase (SY), Oracle (ORCL), Citrix Systems (CTXS), Informatica (INFA), Netscout (NTCT), Progress Software (PRGS), Lawson Software (LWSN) and ADA Softwate (IDAS) are all on my list. Nokia has to be considered. Even at today’s prices, this mobile phone market leader sports a 4% dividend, Also om the hardware side, Pd consider Cisco Systems (in the teens) and even Apple (AAPL) at lowor prices If T am wrong and there is no capitulation and the market rebounds soon, I'll go back to the put options including pnts on RIMM (another dolay for the Bold axlmitted to on Friday), NetLogic Microsystems (NETL) and semiconductor equipmont stocks (KLAC, LRCX). While I've had to be patient, it has all worked out well for me so far. 'The put options paid off as expected (all your long). ‘The “maximum defensive position” has put me in a spot to have lots of finds at the ready if the opportnity prescnts itself I can’t ask for anything more- except a great buying opportunity! Fred Hickey 603-888-3954 ‘To facia the wansmiasion of address changes, fox number ching and the Tika, you may now eral us et the folowing adios ‘hehighechtaegis(@yehoo com, Be foremamed that Iwill nt sca these eras. Only my adiniatar will oe them, aed she’s not prepared to answer any questions sbout the sate of the econemy or articular tech stocks, Those types of questions vl be igncred. Infomation presarted inthis newsetr was obtained fom sous bodied to be reo Lt acouracy and carps an cpiicns ‘ba on this information sno prance Under no creunstanees i this an offer to sell ora slictaton toby secures suggested herein. ‘Taeeditr may haven nies the companies mentioned. Al data ‘nd information and opinions expressed, ar subject o change without One year subscription: $140(U8) (including Canad). Inéerational: $175(US). Check or money order 10 The High ‘Tech Strueyist, payuble to a U.S, banke Three month trial ‘$60(US). Fax delivery avallable for un additional charge of $30, to the US, $75 to international numbers. To subscribe, please send your name, address and check or money order to: The High-Tech Strategist, PO Box 3133, Nashua NH 30613133