Adam Lass is not impressed with either the economy or the market’s prospects at the moment. But he does have some advice for investors looking to buy in this volatile market.

In the long run, it is critical that we parse and pore over Washington’s socialization of our economic system.

I cannot say this often or strongly enough.

The very economic air we breathe has been completely changed. Public pension funds have always had an inordinate effect of Wall Street. But now Washington, D.C. is the single biggest stockholder in the world.

Can you even imagine that Washington will truly be a passive, transparent partner, willing to let the markets act as they will, now that any given administration might just be the fatal loser in this sort of Darwinian natural selection?

A deal they couldn’t refuse

We already know that Washington apparatchiks prefer their own heavy thumbs on the scales to Adam Smith’s invisible hand just as a general principle. But I do believe that a recent meeting in Washington was unique in the history of the United States.

Last Monday, former Goldman Sachs principle and current Glorious Chairman Hank Paulson lined up the heads of most every major bank in America, and informed them all that they now had a new senior partner.

No ifs, no ands, no buts. And no negotiating about terms, price, voting rights or whatnot, either. Here’s the contract. Here’s the pen. Here’s my gun. And there’s the door.

To find a parallel, one must look either to Putin’s recent takeover of the Russian oligarchy, or to Salvatore Maranzano’s violent solution of the Castellammarese War and his conversion of the loosely knit Cosa Nostra into the infamous Five Family System.

Washington’s final solution?

I personally think that Washington is incapable of stewarding our economy through the rough waters ahead. But quite honestly, it will take years if not decades for us to find out the final answer to this question.

And while this intensely interests economic history geeks like myself, strangely enough, it is not the question that is filling my inbox right now. What most of my readers want to know is more immediate: “Was last week the bottom? Are we done losing money? We’ve got a lot of ground to make up. Can we go back to investing now?”

To find the answer to this question, I have suffered through most of the recent statements from government figures such as President Bush, Ben Bernanke and Henry Paulson, and former government insiders like Alan Greenspan, and Paul Volcker.

I have read estimates and accountings from major actors like Warren Buffett and George Soros, and studied the offerings of quiet but significant thinkers like Jeremy Grantham and John Mauldin, Nouriel Roubini (and even my coeditor of this column, Justice Litle).

I have waded through reams of government and private reports and pored over possibly as many a hundred stock and index charts. And I have to say that I am not impressed with either the economy or the market’s prospects at the moment.

700 toxic zombie banks

Let’s start with banks now that Washington is such a major player in this area. Both New York University’s Professor Nouriel Roubini and myself have delivered many early warnings on this topic.

However, where I have been primarily concerned with the possible fates of the 117 on the FDIC’s watch list of dangerously undercapitalized banks, Professor Roubini notes that some 8% of the 8,500 banks the FDIC insures are in just as deep a hole.

Now he warns that despite Washington’s pledge to back each and every bank, in the end, it will be forced to perform triage, and abandon the worst lest they become poisonous “zombies.” One need only look to Japan’s decadelong recession to see what can happen to us should we refuse to bury these walking corpses.

Remember that while Washington may (or may not) be able to protect these banks’ depositors, their investors and bondholders, on the hand, will be forced to join them in the grave.

The REAL crash

But even this agonizing process may take months if not years to play out. Looking to more immediate matters, I must point out some particular items that may have passed under your radar during all this folderol.

For the last few decades, the global economy has hung its hopes on American consumers. And right now, those consumers are hurting.

We have been seeing miserable numbers for over a year. But last month changed the very meaning of the word “bad.” The U.S. Commerce Department (remember them?) has announced that consumer sales fell 1.2% in September.

That’s the steepest drop in over three years, and double August’s reported loss of 0.7%. It’s also the third failing month in a row, the first time this has happened since 1992.

The rot spreads…

Needless to say, I believe that retail stocks will come up very, very short over the next few quarters. However, there is every reason to believe that this collapse will spread outward into other sectors.

The Commerce Department is reporting that inventory is backing up on store and warehouse shelves. And excess inventory inevitably translates into reduced orders for manufacturers. Thus I also recommend that you move away from the industrial stocks that feed into retail.

But it doesn’t end there. This precipitous drop in sales and orders means that stores and manufacturers are laying off workers willy-nilly. And when you either don’t have job, or don’t know if you will have a job, you stop buying (and charging: consumer borrowing has hit a 10-year low).

This roundelay should sound familiar to any investor old enough to drink legally. It is the formula for an entrenched recession. And in point of fact, Professor Roubini joins me in this assessment.

A two-year recession – if we are lucky!

In a way, he is optimistic: He notes that IF we do the right thing (certainly not a given), we just might avoid Japan’s fate, and get away with a mere 24 months of negative growth while the weak hands and walking dead are weeded out of the system.

And now, I am going to say something shocking. It will seem almost contradictory to everything I have just said.

If you can find a company that is not rotten inside, then by all means, buy its shares!

First of all, it almost seems like a patriotic duty, indeed even a human requirement, to support the guys that didn’t drink the Kool-Aid and debase their company and rip off their stockholders.

Investments that will make you proud

These are the companies that you will be glad and indeed honored to own in the decades to come. The gains you make off these straight flyers will in all probability put your kids through college and allow you to retire in style.

And over the next 24 months, they will be available for pennies on the dollar. However, there is only one safe way to acquire these shares in a market this crazy: You simply must buy put option contracts against the worst of Wall Street at the same time.

Stops simply won’t work in this volatile market. But puts will, because their gains will allow you to continue to accrue a portfolio of winners, no matter how bad they are treated.

As I have mentioned repeatedly, this strategy has set up WOW readers for triple-digit gains on virtually every open position in our portfolio. Many of my put contracts have tripled in value. Some have increased fourfold. Can you imagine how gains like these could protect your long portfolio?

As I said earlier, I have perused the histories. I have read the statements. I have looked at the charts. And this is the only path to sanity that I can map out for you.

Please allow me to take a moment to correct a misapprehension on the part of some TD readers: Believe it or not, I do not necessarily enjoy telling you all this bad news.

I may be bearish, but I am NOT a cheerleader for bad times. I do not gloat when good folks see their fortunes go down the tubes. In fact, the news these days makes me sad, very angry and more than a tad nervous.

I tell you these things because I must -- I simply must -- because I cannot stand to see the wool pulled over folks’ eyes. I just can’t stand it when these Wall Street crooks rip folks off. And I cannot abide it when politicians of any stripe try to steal away your rights in the dark of night.

And if I can help just one other person to protect themself from these shills and con men, if I can show anyone how to protect their portfolio against life-changing losses, then I will rant, rave, contradict and instruct ‘til they take away my typewriter and cart my sorry behind away. Email me at alass@taipandaily.com.

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