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How to Prepare for a Double Dip Recession

Written By Brian Hicks

Posted July 4, 2010

Welcome to the Wealth Daily Weekend Edition — our insights from the week in investing and links to our most-read Wealth Daily and sister publication articles.

All is well, according to the White House. The economy is strengthening.


We’re in a continued recovery… that just “won’t feel terrific,” says Helicopter Ben.

But it’s not really true — and Bernanke knows that.

Just one look at yesterday’s jobs number and he knows we’re not recovering.

What’s he supposed to say, though?

“We’re in the eye of a crap storm”?

For exactly how long DC and Bernanke can kick the can down the road, hoping for economic recovery, is anyone’s best guess…

Sure, most economists still think the odds of a double dip are low. But our economy is weak.

This, after trillions of dollars have been pumped into the economy; the banking sector was restarted, the government messed around with housing, and kept the auto industry from burying itself.

Hiring is weak. Even Biden doesn’t think everyone will get their jobs back.

Consumers aren’t happy, as seen in confidence numbers. Debt just rocketed to levels not seen since World War II. Stimulus dollars are running out, debt is spreading across Europe and then there’s the Gulf of Mexico, err, the Black Sea of Mexico.

And we won’t even get into the commercial real estate debacle today. We don’t have the space for it.

Without another shot of stimulus, we’re headed down.

Look, I’m not trying to scare you with economic pessimism… I’m simply trying to protect you and show you how to profit when all goes mad.

And I’ll give you two ways to do so in just a few moments.

But first: A look at why the market could be headed off a cliff

Past recessions started because of Fed over-shooting, trying to control inflationary threats by raising interest rates too high. A recession could then be fixed if the Fed lowered rates.

Nowadays, we have no bullets left in the chamber unless Ben turns on the printing press… or gets the masses to believe that all is well. (It’s not as if buttering up the public is difficult.)

But this recession — or slowdown, or depression, or whatever you want to call it — can’t be reversed unless we see a sharp re-balancing of the economy.

Everything needs to improve. Home prices need to come down.  The unemployment picture is a mess.

Can you imagine if our debt load leads to the downgrade of U.S. AAA credit ratings?

Consumer spending needs to come back sharply — with more, long-term stimulus. This short-term stuff just doesn’t work.

Consumers aren’t so confident anymore

Consumer confidence plummeted sharply this month on job worries. Income is weak. And household debt is still high, which doesn’t leave many people much money to fuel 70% of the economy.

The only reason these people were able to fuel the last market run was because they borrowed through credit cards or against their home. They can’t do that anymore.

Consumers also know that much-needed economic stimulus is dying off. No wonder they’re scared — just look at unemployment insurance, stalling in Congress.

That means more than a million more people could start losing benefits — this week alone!

Retail sales fell hard in May as consumers cut back on buying clothes and cars. Total spending fell 1.2%. And with consumer accounting for some 70% of our growth, things aren’t looking so hot…

There’s little chance, with unemployment numbers, that these people run out and spend.

Then, another 40.2 million Americans are on food stamps since March. That’s up 21% year over year. Close to 46% of those currently unemployed have been out of work for more than six months… and Biden doesn’t think we’ll see all jobs recovered.

We’re finally seeing what unemployment numbers really are post-Census workers.

Why smart traders are shorting the market

Those cheering a recovery are overlooking the fact that tax credits (which fueled buys) are expiring. Housing plummeted after the credits expired. This is the same reason behind home sales just falling 33% in May.

Just look at what happened to Cash for Clunkers. It paid people to buy cars and sales skyrocketed. But when the program ended, sales plummeted. People were simply shifting purchase plans forward to take advantage of a government gift.

Plus, consider that Bush tax cuts are set to expire on January 1, 2011. Given that Congress has no real plans to make those cuts permanent, massive tax spikes will hit… and already cash-strapped consumers will get nailed. The gift is being yanked, and – you guessed it – the economy will take a hit.

So, according to Arthur Laffer’s Tax Hikes and the Coming 2011 Economic Collapse, when those Bush cuts expire, the highest personal income tax will jump to 39.6% from 35%. The highest federal dividend tax rate soars to 39.6% from 15%. The capital gains tax shoots to 20% from 15%. And the estate tax runs to 55% from nothing.  And that doesn’t even include these tax hikes… hitting you real soon.

Now that people know this extra “kick in the pants” is coming, they’ll shift their income, says Laffer:

People can also change the timing of when they earn and receive their income in response to government policies. According to a 2004 U.S. Treasury report, “high income taxpayers accelerated the receipt of wages and year-end bonuses from 1993 to 1992—over $15 billion—in order to avoid the effects of the anticipated increase in the top rate from 31% to 39.6%. At the end of 1993, taxpayers shifted wages and bonuses yet again to avoid the increase in Medicare taxes that went into effect beginning 1994.”

Part of the reason we’re in this mess is because Bernanke couldn’t see the housing bubble the first time around, despite the fact that it was clear as day — common sense, even.

And when the housing bubble finally popped, the Fed fool finally woke up, took Congress and the Treasury Department, and bailed out everything — the banks, bondholders, and Wall Street — at the taxpayers’ expense. 

But these bailouts didn’t change anything.

Even Meredith Whitney thinks housing is heading for its second recession…

There’s no question in my mind that the housing market is headed for a double dip, thanks in part to Option ARM (Adjustable Rate Mortgage) resets.

Option ARMs are considered one of the riskiest kinds of loans made during the housing boom; they have left many borrowers owing much more than their homes are actually worth.

The amount of debt wrapped up in these Option ARMs is much worse than that of subprime. If the government or the banks fail to understand this, the second round we’ve been warning about will begin and banking instability will wreak havoc yet again.

Option ARM resets will be tougher for the economy to handle than subprime. As a result, we will see greater numbers of bank failures, job losses, foreclosures, delinquencies, and economic hardships. Honest.

Just as 2007 and 2008 were the years of subprime woes, this one will go down as the year of Option ARM resets.

With billions in Option ARM resets scheduled to take place in 2010, this crisis won’t be as bad as subprime, of course.

It’ll be worse — for two reasons:

1. Lenders created these ARMs with “teaser” features for borrowers, which included making lower minimal payments for the first few years before the loan reset to a higher payment schedule.

2. If that weren’t bad enough, there was another feature called “negative amortization,” which meant you weren’t paying back any principal. In fact with negative amortization loans, your loan balance increased over time. Incredulously, every time you made a payment, you owed the bank even more. These are the loans that allowed consumers to buy houses they couldn’t otherwise afford.

What should concern you is that about $750 billion-worth of Option ARMs were issued between 2004 and 2007. They will all begin resetting shortly. Banks like Bank of America, JP Morgan Chase, and Wells Fargo are in for a rough ride as a result, given their exposure to Option ARMs.

The next phase of the real estate disaster is upon us. It’s just shifted from subprime to Option ARM, and with many economists predicting unemployment will stay in the double digits, foreclosures will only accelerate. This will add to bank losses, which will add pressure to the financial system and broader economy.

According to Meredith Whitney:

The U.S. housing market will experience a second recession, forcing banks to post additional loan-loss reserves. Most investors are not baking in a double-dip in housing. You’re going to see banks post additional reserves associated with this double-dip in housing, and that means weak performance going forward.

Yep, housing has given consumers reason to pause.

The picture I’ve painted of the future certainly looks bleak…  But you can profit by going short anything housing related.

We did the same thing with subprime… and we’ll do it again during this second round of housing woes.

Our country has too many homes and too many owners in trouble. Foreclosures are expected to rocket to 4.5 million this year from 2.8 million in 2009, according to RealtyTrac.

Another 11 million homes are underwater. Another 2.3 million homes have less than 5% equity. And there are now, according to the Census, two million vacant homes ready to be sold. Plus, another seven to eight million are delinquent on loan repayment…

Mortgage applications are down 40% since the $8,000 rebate program ended.

You also need to know how to turn this delirious situation into cold hard cash.

Two ways to profit from the meltdown

I don’t believe we’ll see economic growth progress again — not until housing is less of a disaster. I said the same thing in 2007 right before calling for the recession and subprime meltdown. And I’m saying it again now.

Our explosive national debt isn’t helping. Heck, Obama already told us that higher debt could lead us into double dip recession back in 2009.

The rebound of 2009 was nothing more than a bounce off a branch to the bottom of a canyon. There may be other branches to break our fall, but the canyon is deep. And unless the government stops spending money and the Fed comes up with a brilliant stimulus plan, things are bleak.

If Bernanke was so confident in our economy, he’d be talking about interest rate increases and not telling us it’ll happen “in the future.”

But here’s how you can profit from a likely collapse.

First, buy gold…. lots and lots of gold

France’s Societe Generale thinks gold stands to rocket to $1,430 an ounce on fears of double dip recession alone. Not on the reality, mind you — but on fear. 

There’s fear that we’ll heading into the second leg of financial chaos with the Eurozone in trouble. There’s also a concern that governments will print their way out of trouble, spiking inflationary risks. These conditions are both great for gold.

Add in geopolitical risks with Iran and Israel, and tensions alone will drive gold higher.

Buy foreclosure processing companies

Only asses think the housing market’s bottomed…

Fact is, three long years and millions of foreclosed homes later, there’s still a wave of foreclosures headed our way — just as we’ve been warning readers about since the early days of 2007.

We’re nowhere near the end of a crisis that could cost us $1.5 trillion.

Yet, there are two very simple ways to profit from the very companies that help process the foreclosures.

We believe they’ll be quite busy, and profitable, over the next few months.

Go where the smart money is going.

The banks are never prepared to deal with the skyrocketing mess that we’re about to face. When these loans were made, everyone foolishly thought that real estate prices would keep skyrocketing.

Nowadays, lenders are outsourcing to select companies that specialize in foreclosure processing — for a hefty fee, I might add. These companies are streamlined to specifically handle the millions of foreclosures we’re about to face.

You can read more about profit opportunity with these companies here.

I leave you with this: Be confident in preparing for downside.

Not all of it is priced in — especially when it comes to housing.

We’re confident that our editors will give you at least one or two investment ideas to mull over through the weekend… you can find those below.

Stay Ahead of the Curve,

Ian L. Cooper
Editor, Wealth Daily

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