Our colleague, Dan Denning, reports that a majority of these ARMs due to reset held initial rates that ranged from 6-9%. This represents subprime territory. And the folks who hold these ARMs, based on Denning’s research, will be facing increases of 30-50%.

Meanwhile, Freddie Mac posted a $2 billion loss last week — three times what analysts had expected. To help shore up this mess, the government-backed mortgage-purchasing firm halved its quarterly dividend and announced it would sell $6 billion of its own stock.

Take a look at that last paragraph… Freddie Mac posted a $2 billion loss last week — three times what analysts had expected.

Meaning, I believe no one really knows how far and deep this thing may go. I’m smart enough to know I certainly don’t. But I do know this.

Bill Gross, chief investment officer at PIMCO, the world’s largest bond fund, stated in the Financial Times this week: “We haven’t faced a downturn like this since the Depression… [The debt market’s] effect on consumption, its effect on future lending attitudes, could bring [America] close to the zero line in terms of economic growth… It does keep me up at night.”

That’s all we need to hear.

This, dear reader, makes us worry.

The AP reports that the Consumer Confidence Index dropped to 87.3, down almost eight points from the revised 95.2 in October. This represents the lowest reading since 85.2 in October 2005, when gas and oil prices soared after hurricanes flooded New Orleans and shut down a large chunk of the nation’s oil refineries.

Except we have no hurricanes. What we do have are interminable military obligations, crumbling infrastructure, rising prices, a declining dollar and a credit crisis with no end in sight.

But don’t tell that to the My Super Sweet 16 crowd. They’re busy preparing for their most important coming-of-age celebration. Heck, they might even have the right idea. Just close your eyes and hope for the best.

But all hope may not be lost.

Our friends at the Rude Awakening report that one of my Free Market Investor picks, which happens to be Europe’s largest bank by market value, agreed to absorb $45 billion of assets from the structured investment vehicles (SIVs) it controls. In other words, the big bank agreed to take responsibility for $45 billion worth of questionable asset-backed securities (ABS).

We applaud the bank’s forthright approach.

By contrast, Citigroup has refused to assume direct responsibility for the $83 billion of questionable ABS that it controls inside its SIVs.

Citigroup turned to the state-owned Abu Dhabi Investment Authority earlier this week for a $7.5 billion infusion. Citi agreed to sell a 4.9% stake to the investment fund, making it the bank’s largest shareholder, overtaking Saudi Prince Al-Walid bin Talal.

Unlike with my European bank, we still have no clue as to the true depth of Citi’s SIV liabilities. Rude editor Eric Fry says it best: “Citi agreed to sell part of itself to the Abu Dhabi Investment Authority for $7.5 billion — a recapitalization deal which, conveniently, admits to no crisis, acknowledges no error, eliminates no executive positions, reduces no executive bonuses and solves absolutely no problems. The deal merely perpetuates the status quo — the same inept and broken status quo — a system that nourishes corrupt mediocrity, while squandering shareholder capital and crowding out legitimate economic endeavors.”

But the unbridled belief in the greatest story never told marches on. Earnings reports remain strong, they say.

Well, as we’ve said before, even the companies representing the Standard & Poor’s 500 Index now derive 49% of revenue from foreign markets, up from 30% in 2001.

Meaning strong American earnings don’t necessarily correlate to a strong American economy. At the very least, a vote for the S&P also means a vote for globalization.

But don’t take it from us.

Our friends at The Economist report: “As international investors wake up to the relative weakening of America’s economic power, they will surely question why they hold the bulk of their wealth in dollars… The dollar’s decline already amounts to the biggest default in history, having wiped far more off the value of foreigners’ assets than any emerging market has ever done.”

But despite all of this, most American brokers fear international markets.

Well, if you had invested a mere $100 in the member companies representing the Hang Seng Index upon its inception in 1964, your meager $100 investment would have been worth more than $30,000 today.

By comparison, that same $100 invested in the Dow Jones Industrial Average would have risen only to $1,500.

It’s your money…

Until next time,
Christopher Hancock
November 30, 2007

P.S.: My Free Market Investor readers have seen some pretty nice gains recently. They are about to see those same gains with the bank stock that I mentioned above. I can’t give it away here. That would be unfair to my other readers.

Investing in European Banks was originally featured in the Penny Sleuth.

I heard on CNBC earlier this week that 50% of all sales by U.S. companies were made in foreign markets. That’s 50%.

And considering those sales are made in foreign currencies that continue rising relative to the greenback, it makes you wonder the real reason earnings reports remain strong.

Considering the dollar just hit a 26-year low against the sterling while the Euro creeps towards record levels against the greenback as well, it seems one would have to factor a portion of this first quarter earnings strength to currency exchange rates.

I also find it a bit disconcerting that American companies seem to rely more and more on foreign consumers.

Let’s face it… American’s have little left to spend. We save nothing, consume by borrowing and rely on a fundamentally and morally bankrupt entitlement system to make the headache all go away.

I’m not calling for the complete collapse of the American empire…but the undeniable shift of capital to foreign markets has to make you stop and think.

According to Tim Hanson at The Motley Fool, nine of the 10 largest IPOs of 2006 and 24 of the 25 largest IPOs of 2005 occurred in foreign markets.

To me, all this means one thing: It makes more and more sense for American investors to start allocating a greater percentage of their portfolios in foreign markets.

Hansen goes on to point out that foreign holdings now account for 17% of all U.S. stock ownership.

Personally, at the moment I have roughly 83% of my entire equity portfolio in foreign stocks.

And even though approximately 50% of the world’s population rests in Asia — the region of the world experiencing the most dynamic growth — I certainly don’t place all of my eggs in the Asian basket. There are plenty of great buys in Latin America and Western Europe as well.

Now there’s no denying that last year alone, the emerging markets around the Pacific rim accounted for more than half the world GDP. They now churn out 43% of the world’s exports and hold 70% of the world’s foreign exchange reserves.

And while real wages in the developed west are either flat or falling, wages among the up and coming nations of Southeast Asia continue growing.

It would be silly to ignore this. But remember, successful investing will require buying shares of businesses at the right prices.

And right now, for what it’s worth, China is anything but cheap.

But we’ll keep looking… This story won’t play out overnight.

Until Next Time,
Christopher Hancock
April 27, 2007

Relation of Small-Caps to Consumer Spending was originally featured in the Penny Sleuth.