Eric Roseman's Eruptions: Stocks, Global Markets and Commodities BLOG

LIBOR Rates Finally Easing, but Riskier Credits still Stressed

For the first time since July, LIBOR rates have started to ease. That’s good news for global investors as recent government guarantees to protect banking systems and inject hundreds of billions of dollars into interbank lending rates begins to show signs of improvement.

This morning, three-month LIBOR sits at 4.42%, down from over 4.81% on Monday morning. The Federal Funds rate, set by the Federal Reserve, is at 1.50%. Typically, in a normalized credit environment LIBOR trades about 50 basis points or 0.5% above the Federal Funds rate. Similar overnight lending rates across Europe and Asia are also declining this week.

LIBOR, or the London Interbank Offered Rate, is a crucial U.S. dollar lending rate tied to over $360 trillion dollars’ worth of financial products worldwide. Critics of the rate, which has remained historically high since last year, blame the British method of calculating the index. A new model was subsequently calculated in New York several months ago by American bankers to determine if London LIBOR rates were accurately reflecting the nervous state of interbank lending markets. The results concluded London LIBOR is indeed accurate.

The TED spread, or the difference between three-month Treasury bills and three-month LIBOR, has also dropped this week to 397 basis points from 464 basis points last Friday. The TED spread hit its highest level since 1984 on October 10.

Though still a glacial decline considering the vast amounts of capital pledged to be injected in global banking systems, the fact that interbank lending rates have begun to normalize is a positive development. The market is starting to price a relaxation of credit stress; this process won’t happen overnight since government guarantees will take time to filter through the broader global economy. Still, this is very good news for nervous investors.

Another beneficiary of government short-term debt guarantees to banks is the investment-grade corporate bond sector.

Investment-grade bonds, dominated by large-cap financial companies, imploded over the last three weeks with indexes for AA, A and BBB credits plunging more than 15%. The sector has never posted such vicious declines in such a short period of time. The Dow Jones Corporate Bond Index now yields 8.69% this morning or a hefty 4.77% above Treasury bonds. In my book, this sector remains the best value for all investors seeking high yield, value and the prospect for capital gains.

But I’m still seeing significant stress across the riskier segment of the yield curve. This tells investors that the broader economy is still weakening as credit lending remains tight, defaults are rising and more companies are headed to bankruptcy.

Junk bonds, emerging market bonds, convertible bonds and other risky credits have continued to decline this week. I’d be more encouraged about LIBOR’s progress this week if this rally was confirmed by tightening credit spreads for high-risk bonds; that’s not happening.
I’m standing by my forecast from last week that global stocks are extremely oversold and poised to rally following weeks of relentless selling. Lower LIBOR rates are a plus.

However, don’t be fooled by new bull market chatter; this remains a secular bear market for stocks as the economy digs deeper into recession over the next six months. Use any rally as another opportunity to sell unwanted stocks and remain highly liquid. Before this is over, the Dow should test or re-test its October 2002 low of 7,286. The economy is far worse today compared to the last recession six years ago. Stay defensive.

Have a nice weekend. See you on Monday.

The Hedge Fund Threat

The big global financial unwinding has been exacerbated if not spearheaded by hedge funds this year. And as we approach December 31, more hedge funds will have to dump stocks to meet investor redemptions.

Hedge funds have failed miserably to protect their investors in 2008, an extraordinarily challenging year for even the most seasoned traders. Some managers, including SAC Capital and Paul Tudor Jones, among the best in the industry, have recently liquidated their entire portfolios and are sitting in cash since September.

Hedge funds have ballooned over the last 20 years. The industry went into overdrive at the start of this decade and won kudos by 2003 for largely protecting investors in the 2000-2002 bear market. Hedge fund assets are estimated at $2.8 trillion dollars through April 30.

The majority of strategies have been massacred over the last 12 months with September the worst month for hedge funds in history.

In 2008, the Credit Suisse Tremont Blue Chip Index of hedge funds has plunged 12.5% through September 30 and is down again thus far in October. In September, the index tanked 7.8% compared to a loss of 9% for the S&P 500 Index and -12% for the MSCI World Index.

The worst-performing strategies include convertible arbitrage (-27%), long/short hedge funds
(-21%) and emerging market hedge funds (-15%). The only sector that has gained in the Credit Suisse Tremont Blue Chip Index is managed futures, up 7.5% this year. Keep in mind that managed futures or Commodity Trading Advisors aren’t even part of the hedge fund family since they trade exclusively in futures and options contracts.

Even the short-sellers, which surged in value leading up to September, were mauled last month because of sudden SEC changes to short-selling rules affecting the financial sector. The short-sellers were hammered in September, down a crushing 18%.

It’s unfair to suggest that all hedge funds are gunslingers. They’re not. Several global macro hedge funds, which specialize in determining macroeconomic trends first and then applying a long/short formula thereafter have thrived this year, mostly because of remaining net short, or betting against the market.

What really irks me, however, is that most long/short equity hedge funds have no clue how to short stocks. Shorting is a highly disciplined technique and most money-managers simply don’t know how to protect capital; yet despite losing big money this year in the worst rout for the markets in more than 75 years, these guys have been charging a 20% incentive fees all along while trailing the S&P 500 Index. What a con-job.

Hedge funds are definitely part of the problem affecting global markets. The vast amounts of leverage they’ve employed are now coming home to roost. This unwinding process is still in progress this week as traders sell just about everything to raise liquidity.

By the end of the year I expect many hedge funds to shutter as margins suffer, incentive fees disappear and investors head for the exits. This boom is now a bust.

Solvency Attained but at a Huge Price

No bread lines for now…and that’s a good thing.

The United States and other major economies have rescued the financial sector. The threat of imminent bank failures across the industrialized countries coupled by questionable counter-party risk has all but ended at this juncture. That’s good news for global investors, depositors, businesses and individuals alike following weeks of financial market turmoil that culminated into a global stock market crash last week.

For the week ending October 10, U.S. stocks suffered their worst weekly plunge since 1932. On Monday, the Dow and many foreign markets posted their best single day of gains in history.

Just how the government and the private sector will mesh is another story.

The United States and the United Kingdom are now the most aggressive lenders and owners of their domestic banking systems and how they direct and manage these companies will dictate the fortunes of not only shareholders in these companies but the future of global investing. I’ve got a bad feeling about government in the private sector; the sooner the government finishes its job stabilizing and recapitalizing the banking sector, the better.

For now, we’re stuck with a financial services sector that largely falls directly under government control for the first time since the Great Depression.

Debt ratios will now skyrocket everywhere, including the euro-zone where strict 3% spending limits relative to GDP as imposed by the Maastricht Treaty will be breached like a hot knife through butter; everyone, including the Germans, will open their purse strings in a huge way to accommodate bank liquidity and lending. We will have a different financial marketplace going forward with far more government regulation and control. I`m sure George Orwell, author of 1984, is spinning in his grave right now.

One thing is for sure: Global long-term interest rates, especially American bond yields, are going to rise significantly over the next three to five years. In addition to death and taxes, I`d bet higher long-term rates are almost a 100% guarantee in this life following a tidal wave of government guarantees and bailouts of the financial sector.

Funding costs will surge for the Treasury and I`ve got to believe the Chinese, Japanese and other big holders of Treasury paper will want higher interest rates to compensate for holding heavily indebted U.S. paper. Though the Fed can manipulate the short-end of the market, it can`t control the long end. And that`s where investors can look to make money as long-term interest rates eventually rise once deflation is finally quashed.

The systemic risk to the financial system is now behind us. That’s the good news. The bad news is that consumers and companies along with the rest of the real economy will continue to feel strained by tepid economic conditions, still weak inter-bank lending and lousy corporate earnings for at least the next six months.

Thriving on Chaos

Bet on chaos…and thrive.

As the global financial landscape dramatically changes over the next several months ahead of new government regulation and partial or full nationalization of the banking industry, investors will have to look to alternative investment strategies to produce absolute returns. It is highly likely that some of the most important changes to existing securities laws and regulations since the Great Depression are forthcoming.

Stocks, despite offering great values at these busted levels, won’t secure a retirement over the next few years. Asset allocation will be a key determining factor. Investors will have to look to alternative sources of capital gains that can thrive amid total market chaos. That means placing a portion of your assets into investments that can appreciate even when the markets are in a virtual nosedive.

Chaos to the Rescue!

Last December I introduced a new crisis investing portfolio in The Sovereign Individual called the Chaos Portfolio.

While virtually everything has plunged over the last several days amid total panic, the TSI Chaos Portfolio has surged. In October, this equally-weighted strategy has rocketed 16% compared to a crushing 25% loss for the S&P 500 Index. Year-to-date, the TSI Chaos Portfolio has soared a cumulative 34%, including dividends, compared to a mind-blowing 43% crash for the S&P 500 Index.

To be sure, many of my stock recommendations have plummeted in value this year as stop-losses are triggered like a pinball machine; the only strategy thriving in this mess is literally one based on total chaos.

What makes the Chaos Portfolio thrive is, well, chaos. A near complete breakdown of the financial system is exactly what makes this strategy excel. It’s easy to trade, cost-effective and any investor can participate even with a small initial investment.

Total Crash

The events now unfolding in the United States and overseas are the most significant financial developments since the 1930s. Investors have been crushed. Institutional portfolios have been mauled and retirement accounts lay in near ruins following huge double-digit losses. This is the worst bear market since the 1973-1974 Nixon years and, in some cases, on par with the Great Crash of 1929. The losses are truly horrific.

Global markets are roiling. Despite numerous government efforts to introduce market backstops and massive injections of liquidity to grease clogged credit markets, we’re still in a freefall. I expect coordinated government intervention to eventually arrest – if only temporarily – the bloodletting now infecting global asset values.

Sell on Strength, not in a Panic

A massive short-term up-crash or spectacular market rally is highly likely at this point.

History strongly suggests at least a 20-40% rally lies ahead following a hugely oversold period for common stocks. Even in the midst of protracted bear markets, stocks can muster huge rallies. This occurred on numerous occasions since 1929 with stocks surging from 1934 to 1936 before declining again. Stocks also posted an intermittent 40% gain in the 1968 to 1972 period while also recording impressive annual returns in the post-1974 period before finally bottoming in 1982.

Yesterday’s up-crash was no surprise as governments work overtime to reassure investors and inject additional doses of liquidity into inter-bank lending markets. Confidence will return to capital markets, if only for a while.

Many companies with strong balance-sheets and strong cash-flows have been trashed. In fact, U.S. blue-chip stocks harbour more than $650 billion dollars in cash right now and, in some cases, are probably more solvent than most governments and municipalities.

For investors with a five year investment horizon or more, this is exactly the time to start cherry-picking some of the best names in the United States. I would still avoid the financials. But many superb companies with strong global brands and no need to secure short-term financing are selling at five-year lows. Many stocks also pay high dividends.

What to do Now

Regardless of your age or tolerance for risk, investors should be at least 50% in cash or cash equivalents now. Make sure your funds are safe or deposited in banks that are FDIC-protected. Cash is vital because it will allow you to buy hugely distressed assets in stocks and credit markets over the next 12-24 months.

Alternatively, short-term Treasury bonds are a good safe-haven from the carnage and uncertainty affecting the global financial system. If you buy a money-market fund then make sure it’s a “government” or Treasury” designated product.

For stocks, don’t panic. The worst possible thing an investor can do in this dangerous environment is panic.

If you own stocks that you’d like to sell -- then take advantage of this rally. But again, if you have at least a five year investment horizon then start nibbling at select blue-chips now. The time to buy these great distressed companies is when prices are at a multi-year low, not when stocks trade near or at all-time highs.

Don’t forget about gold. I suspect global central banks have been suppressing the price of gold in this panic. Gold supplies are razor thin and most investors can’t access coins or bars in the United States or Europe. Global gold production in 2008 is basically flat with no new mine production expected until at least mid-2009. I can’t believe gold isn’t trading north of $1,500 right now; yet before this crisis is finally laid to rest, I think gold prices will fetch more than $2,000 an ounce.

However, I expect gold prices to decline following any concerted policy announcement from the G-7 industrialized countries to arrest the ongoing crisis; that’s when I plan on adding to my gold positions.

Gold should represent at least 10% of your portfolio. Any intermittent stock market rally accompanied by a relaxation of credit stress should be viewed as an opportunity to buy gold and other chaos-related investments that can thrive when uncertainty rules.

A big bear market stock market rally is highly likely. As it progresses, sell into strength and buy into chaos. I expect chaos insurance-related investments to become much cheaper over the next several days as this bear market rally intensifies.

Why Gold Stocks Failed

Since the start of the credit crisis in August 2007, the XAU Gold & Silver Index of mostly large-cap mining stocks has tumbled 27%. In October alone – the worst month for investors in global stocks since August 1998 – the XAU Index has tanked 20%.

Gold bullion, however, has gained a cumulative 26% since the outbreak of credit panic in August 2007 while in a crash month in October gold has declined only 2%.

What ever happened to gold stocks protecting portfolios amid a market crash? Why have gold stocks disconnected from gold bullion lately?

On occasion, gold and gold stocks can deviate from each other. This is why it remains fundamental to hold physical gold (bars, coins, certificates) AND the gold mining stocks as part of a precious metals strategy.

Historically, this has occurred during extreme market circumstances like back in late 1979 when gold stocks collapsed and gold bullion was gaining traction ahead of $850 an ounce by January 1980.

The same phenomenon has occurred over the last 12 months with gold stocks absolutely mauled while physical gold has rallied.

Divergence in the precious metals sector can occur, and when it does it’s usually quite painful for those holding gold stocks.

In 2008, the XAU Index has plummeted 42% to a 3.5 year low with gold stocks now trading at a seven year high compared to the physical metal judging by the gold-to-XAU Index ratio. This implies gold stocks are absurdly cheap compared to the metal.

Gold stocks have failed badly this year, despite the fact mine production will be flat in 2008, demand is booming among nervous investors and European private banks have to wait almost three weeks to fill orders for clients – there’s barely any net supply of gold.

This is the time to hold both gold and the gold stocks, including silver.

The ongoing shift from a world obsessed with rising inflation has peaked since July. The major focus now is accelerated deflation, or an environment of rapidly declining asset values. This is the first time since the 1930s that prices worldwide are simultaneously falling together – stocks, bonds (non-government), real estate, hedge funds and other financial assets.

In the scramble for liquidity investors have thrown out the gold stocks in this panic, and since last Wednesday, have even started to sell Treasury bonds to meet liquidity provisions or margin calls.
In a deflation, gold should hold its value but anything traded on the stock market is unlikely to rise in value as the Wall Street tidal wave sinks all ships.

Eventually, the world will reflate again. Budget deficit targets in Europe will be smashed, the United States will expand credit like a monster and in time inflation will make a big comeback – far more serious than what has occurred until recently.

I expect gold stocks to probably double from these bombed-out levels over the next 12-36 months. Prices are extremely low. I feel the pain as a gold-bug but remain steadfast because the dollar and other currencies are simply poor long-term stores of value. The cost of this bail-out, now global, will be enormous and will continue to rise. Be patient with gold and the gold stocks. Salvation is coming.

Don’t Sell Stocks Now

This is NOT the time to sell stocks. In fact, if you’re clamoring to dump stocks because you’re in a state of absolute discontent, then you’ll have your moment very soon.

The VIX or Chicago Board Options Exchange Volatility Index is now in record territory ahead of this morning’s opening on Wall Street. This fear gauge is now completely off the charts (see chart below).

Panic has gripped global investors and stocks are getting pounded like there’s no tomorrow as fear rules the marketplace. The VIX is now trading at 63.92 – an all-time high. Previous extreme readings like this one have portended to massive market reversals.

I’m not sure what policy initiative will instill confidence in this market, but it’s coming. Stocks are extremely oversold and will post a massive up-crash that might last several days or more. That’s your opportunity to sell into a bear market rally.

Previous secular bear markets like this one have resulted in enormous short-term rallies. For example, between 1968 and 1972 the Dow gained 40% in a bear market rally before tanking again. This also occurred in the post-1974 period on several occasions as stocks mustered huge gains before heading into the basement again. And even during the Great Depression stocks posted huge gains from 1933 to 1936. Big bear market rallies do occur and this time won’t be any different.

I was actually encouraged by IBM’s earnings yesterday and Big Blue’s ability to secure short-term financing. But the market doesn’t care. The big picture is highly bearish and investors have completely lost confidence in the market, the economy and the ability of credit markets to get functioning again. And that’s what a panic is all about – a lack of confidence.

For my personal funds, I added (again) to big blue-chip names on Thursday. I’m still avoiding the banks where I’ve taken a bath this year but remain committed to companies with strong balance-sheets, great brand-name recognition and good earnings. Yes, there are many large-cap companies still making money in this mess. If you’re investment horizon is five years or more than this is the time to cherry-pick those names.

Amazingly, most investors are incredibly conditioned to chase prices higher when stock prices are soaring; yet, the opposite is true when prices are falling.

We’re a long way from a new bull market. There’s no disputing that. The United States and other countries are embarking on a long and painful cycle of de-leveraging that will take a while to cleanse. This won’t be a pretty environment for investors. Yet despite the ongoing carnage to our portfolios don’t forget that the best time to buy for the long haul is exactly when prices are this cheap. Legendary value investor Sir John Templeton would be a buyer today or at least dollar-cost-averaging into his favorite stocks at the point of what he called, ‘maximum pessimism.”

Have a good weekend. See you on Monday.

Running out of Bullets

Despite a concerted global central bank rate cut this morning, world markets are still declining. Overnight, stocks in Asia crashed another 5% and the Dow futures look pretty grim.

The Fed and other major central banks, including the Chinese, cut benchmark rates by 0.50% today. Though U.S. stock market futures were higher at 8am this morning, they’ve since turned negative. The Dow has now plunged more than 15% in six days.

Global stock markets are now posting their worst calendar year loss since 1974. The MSCI World Index is down a mind-boggling 35% heading into this morning’s trade; the MSCI Emerging Markets Index has crashed 47% -- its worst loss in 20 years.

The Fed and other central banks are now throwing all they’ve got at the credit crisis. This is a monetary conflict of the first degree for central banks as they fight the growing threat of accelerated asset price deflation across world markets. Key asset values, including housing, equities and credit are all collapsing in value this year and the rate of decline has accelerated markedly since September 1.

The Federal Reserve continues to do the right thing to alleviate credit stress. Bernanke is the right guy for this job. The Fed has an enormous array of policy response tools at its disposal; combined with other central banks, the Fed will eventually arrest deflation through an unprecedented expansion of bank credit. If not, we’re in serious trouble because this gun is quckly running out of bullets.

Last night, for the first time since the Great Depression, the Fed became the lender of “only” resort to the massive commercial paper market. The Fed will now directly loan to the biggest companies, including General Electric, which require commercial loans to pay for inventory, salaries and account payables to suppliers. Again, the Fed is doing the right thing because banks are not lending – not even to AA and A credits like GE.

I know this is an extremely difficult time for investors. We’re all witnessing a massive purge on our assets over the last 12 months and the latest bout of panic-selling has everyone on edge. But please keep a cool head. By now your portfolio should have at least 50% in cash with equities representing an under-weighting. You should also have reverse-index funds, like DOG or SH representing about 20% of your assets. Gold should be at least 10%.

If you don’t have the above allocation or something that looks similar, then you’re bleeding heavily. Wait for a big rebound, which is coming, to sell any unwanted stocks. The last thing you should be doing is selling amid a panic. Be cool and sell on intermittent strength. It’s coming.

Tomorrow is Yom Kippur. I’ll be back Friday morning. Stay strong.

Massive Rebound Ahead as Fear Gauge Skyrockets

I’m certainly not predicting a new bull market any time soon. The United States and the majority of foreign economies will continue to come to grips with a protracted slowdown that will curtail consumption, inhibit expansion and result in a long economic recession. The damage done to the financial system has been monumental these last few months. There is nothing central banks can do to reverse that – we’re too deep in the cesspool.

But stocks and weaker credits are going to muster a spectacular short-term rally – and soon.

The fear gauges I track are completely off the charts heading into Tuesday’s trading.

The most telling of these indicators is the VIX, the Chicago Board Options Exchange Volatility Index. The VIX is down more than 8% today and that’s a good sign because its direction since late August has been parabolic.

The VIX hit the record books on Monday as global markets swooned again. At 52.05 before the start of today’s trade, the VIX is trading at maximum pessimism as investors scramble amid the worst global panic since the 1973-1974 crash.

History suggests that a significant turning point lies ahead for stocks, which are tremendously oversold. A rally will ensue and it’s likely to be quite powerful.

October 6 probably came close to marking a short-term bottom for equities. The advance-decline line on the NYSE hit unbelievable numbers yesterday with New Highs at 13 (almost entirely comprised of short dedicated ETFs) and a mind-blowing 1,973 New Lows. Advancing volume was just 119,572,320 compared to declining volume of 1,753,362,656. This data tells you that we’re heavily oversold and stocks are going to post at least a big bear market bounce at any time.

There are two types of investors in this bear market: The smart ones and the nervous Nellies.

The nervous Nellies are in a total state of panic and dumping everything on any given day stocks post a big loss, disappointed the market won’t stabilize. These investors, if you can call them that, will probably be out of the market for years to come once this chaos concludes. They really have no business being in the market in the first place.

The smart investors are concerned, of course, but are cool and calm.

The smart investors are selling into strength or on days when stocks advance. Other smart investors are even buying their favorite stocks at big discounts compared to just a few weeks ago. Warren Buffett is one of these investors. You can cherry-pick or average-down some great companies right now but you must have at least a 5 year investment horizon.

Also, gold should be at least 10% of your personal net worth at this point – if you can get it.

There’s a major shortage of physical gold right now in the United States and Europe. I’m disappointed gold isn’t trading north of $1,500 at this point amid the panic.

With supply shortages now becoming acute and production growth almost non-existent this year, I’m still forecasting at least $2,500 gold before this bull market is over. With all the massive expansion of credit coming our way in this world over the next few years everyone, regardless of age or risk tolerance, should have at least 10% of their assets in physical gold bullion, coins or gold certificates. If you can’t access any of these three avenues, then buy a gold exchange traded fund.

Gold is the only physical asset out there right now that isn’t deflating. In the last great deflation of the 1930s, FDR confiscated gold. I have a feeling gold prices can rise in a deflationary economy. This might yet be its finest moment.

Global REIT Boom Ends with a Thud

One of the biggest casualties of the global financial crisis is the big bust now underway in REITs, or real estate investment trusts. Until mid-2007, U.S. REITs dominated global investment performance in the post-2000 technology stock “bubble” era with eye-popping 25% annualized returns.

International REITs were even more profitable, especially for dollar-based investors as foreign currency returns boosted profits combined with rising dividend distributions. A blizzard of international and regional REIT mutual funds and exchange traded funds (ETFs) were launched since 2005 as global demand went off the charts.

Singapore and Western Europe spearheaded some of the most impressive returns over the last several years with eye-popping double-digit annual gains, including a profitable recommendation for one of Singapore’s largest and oldest commercial REITs two years ago in The Sovereign Individual.

The REIT Crash

Since the onset of the subprime mortgage crisis 14 months ago REITs have plunged in value – with the biggest declines occurring in Europe, Eastern Europe and Asia.

REITs have boomed recently in the Pacific whereby recent legislation was introduced permitting REIT structures over the last seven years in Japan, Singapore and Hong Kong.

But in Singapore, REITs have plummeted more than 15% over the last 12 months and are down in excess of 45% in Australia. In Japan, J-REITs have tanked almost 30% over the last 12 months and remain 25% off their best levels in the United States.

Too Much Supply, Lack of Credit

The turning point for REITs occurred in early 2007 as the “bubble” began to simmer following an enormous number of new offerings worldwide. Fueled by the lowest interest rates in a generation combined with easy credit, REIT sponsors went hog-wild.

Supply and demand always dictate price action for any secular trend; in this case, REIT initial public offerings or IPOs were all the rage across the United States, Europe and especially Asia starting in 2005. Any observant investor could have easily identified that trouble was brewing in early 2007.

The Big Squeeze

In addition to abundant supply, the ongoing credit crisis has also hit REIT values hard over the last year. That’s because REITs require a stable lending environment as developers and property managers require access to credit to expand or modernize existing properties. With even the highest quality of loan candidates struggling to raise capital this year it’s no wonder the sector has correlated almost perfectly with bank stocks.

In Asia, 2008 has been especially painful for REITs as the growing credit crisis, falling stock markets and plunging asset prices resulted in the cancellation of offerings.

Some smaller and mid-sized REITs are now threatened by questionable business models in the wake of a credit squeeze developing in the region where it has become much harder to raise equity and debt to finance deals. It’s the same phenomenon spreading to Europe and even fast-growing Eastern Europe as REIT values have collapsed. Even in red-hot China many construction companies have either failed or remain technically insolvent as the big real estate boom cools across many cities.

Beyond the Bear

The United States REIT sector might lead the rest of the sector to recovery over the next 12 months, assuming the credit crisis ends and banks begin lending again.

While U.S. REITs have shown signs of bottoming this year, regional REITs in Europe and the Pacific are still in the midst of sharp corrections.

Indeed, as economic growth slows across Europe and Asia over the next several months and more credit-related turmoil spreads to Europe, the United States is starting to look like a relative safe-haven. That’s because the ongoing credit crisis hit America first and with the latest passage of the bailout bill in Congress on October 2, markets might start looking at the United States REIT sector as a bell-weather ahead of a recovery.

Since July, the iShares Real Estate ETF (NYSE-IYR) has gained almost 10%, excluding dividends. It’s the same story for most banks over the same period, boosted by the Securities and Exchange Commission (SEC) short selling ban.

The U.S. REIT sector is worth watching carefully. The sector has already been trashed and, from a technical perspective, appears to have formed at least a short-term bottom in late July. Sentiment should improve following the bailout bill. Still, the country is now in an economic recession and the ongoing contraction might last longer than average recessions in the past because of the massive accumulation of debt and leverage-loan financing prior to 2007.

Pacific REITs will likely be forced to consolidate in the months ahead and that will pose regulatory challenges to corporate charters and shareholders. It’s too early to buy Asian REITs.

Europe, on the other hand, now faces a deeper credit squeeze as bailouts and a new wave of failures comes home to roost. The United Kingdom, Ireland, Spain and Denmark are all home to big real estate busts and it’s spreading. It is unlikely European REITs will bottom until at least late 2009.

Bigger Bargains in Spain, U.S. Foreclosures

For individual investors, especially dollar-based investors, the ongoing contraction in sun-belt values across the Spanish coast looks appealing.

The U.S. dollar is mustering a powerful bear market rally since its July lows and has already soared more than 13% over the last ten weeks against the euro. Combined with lower interest rates across the euro-zone later this fall or into 2009, financing costs should become more affordable for prospective buyers looking for a bargain in the popular Costa del Sol region.

In the United States, more government auctioned foreclosures loom in 2009 and that means big bargains for speculators and investors alike. Banks are desperate to remove non-performing loans in their clogged portfolio of real estate deals.

The last bear market in U.S. residential property in the early 1990s resulted in a plethora of deals for distressed buyers in Florida and California, among other states. This bout of real estate deflation now widespread across many regions and deepest in the American sunbelts of California, Arizona, Nevada and Florida will result in even greater bargains. It’s no wonder Europeans have been active buyers of U.S. real estate since 2007 amid a strong euro until recently. Now it’s time for Americans to buy domestic, too.

Commodities Plunge Signals Deflation

Is the bull market over for commodities?

That all depends on how successful global central banks can engineer a new round of inflation as an environment of accelerated deflation or falling prices continues to plague world markets. Make no mistake about it, this is deflation.

Amid a surging dollar since July commodities have tanked more than 25% with crude oil prices about to post their worst weekly performance in four years. Even gold, a sanctuary in uncertain economic times, has faltered this week despite five bank failures across Europe.

Right now deflation is winning as global economic growth slows or, in some cases, contracts. The dollar has emerged as King. But over the next several months I think global central banks will cut lending rates, perhaps even aggressively to stimulate growth and, invariably, inflation. It’s literally “Inflate or Die” for the world’s central banks, including the Fed.

Rapidly declining prices are now widespread in housing, credit, stocks and commodities. The last time all major asset classes were purged this hard was back in the 1930s. The only major asset class still gaining value is Treasury bonds, up more than 13% year-over-year.

Global markets have placed new bets since July as we’ve transitioned from inflation to deflation for the first time since 2001. It’s been a huge reversal with hard assets like oil, the grains and industrial metals plunging, foreign currencies tumbling and stocks markets worldwide collapsing.

What’s happening now is the big reversal of “easy money,” or the death of the carry-trade, which relied on cheap funding costs and leverage. The entire global marketplace is now unwinding leverage and the resultant shift is highly deflationary as risk is aggressively reduced coupled with far less liquidity.

Is there any good news?

Assuming central banks print credit and do everything they can to contain deflation and support the financial system, then yes, markets will find a bottom. But I’m afraid we won’t see a bottom for at least another 3-6 months because this train is running fast, cutting economic growth and instilling fear among consumers. It’s also an environment that is not supportive of corporate earnings.

Remain highly liquid, maintain low equity market exposure and keep those reverse-index hedges. Also, don’t give up on gold. We’re all going to pay for this spectacular expansion of credit over the next five years – and that means high inflation.

Enjoy your weekend. See you on Monday.