Sunday, January 4, 2009


2008 Recap.

The best thing about 2008 is that it's over, a tough year for markets and economies worldwide. Paying attention to the stock market, equities, and our portfolios was as much fun as watching a cancer patient on chemotherapy. The majority of "experts" and pundits did not predict the downturn, and were caught off-guard by its severity and rapid decline.

But with the benefit of hindsight we now know for sure:

- This is a recession, which started in December 2007, and is now entering its 14th month. Our thanks to the U.S. Bureau of Economic Research for their December 1, 2008 report notifying us of this fact. We are looking forward to their next report stating the recession is over, a year after the fact.
- The stock market "correction" of August 2007 was not a correction but the start of a new bear market, preceding the recession by 4 months.

The U.S. stock market established a bottom on October 10, 2008 with the Dow at 7,900, and in a typical bear market move re-tested it a month later at 7,500. I expect future rallies to be short lived, and the lows re-tested a few times before the next secular bull market, which should be sometimes around Fall of this year.

Where are we headed now?

The longest recession on record was 43 months, following the 1929 stock market crash. The same "experts" who were wondering whether this was a recession, are now debating if this one will be like the Great Depression, Japan's self inflicted 18 years downturn, or a 1973-1974 style recession with a recovery late this year. I am betting on the latter.

The several $ trillions injected in the form of fiscal stimulus, financial and auto industry bailouts, near zero interest rates, and upcoming new infrastructure investments will find their way into the economy and start a new cycle, eventually. 2009 will be a year of transition on the way to recovery, with the next economic cycle driven by a back-to-basics focus on infrastructure, alternative energy technologies, and corporate capital investments as opposed to consumer spending.

The American consumer is bruised but not dead, and will shop again. Lower interest rates and fuel prices will provide more discretionary income, which will go toward debt reduction and slowly restore houselhold financial health. Jobs will drive consumption as opposed to the other way around.

Families continue to multiply and need new housing. This, along with a 75% reduction in new construction, lower interest rates, and return-to-normal bank lending, will help supply and demand get in check, eventually restoring real estate prices. It is important to note that, although we have been struggling with an over-supply due to excessive building, new foreclosed inventory, and qualified home buyers kept out of the market by frozen lending, demand for housing is still stable at roughly 5 million homes a year. The 2 million houses in foreclosure will be absorbed this year as banks liquidate them, finishing the end of the real estate downturn and restoring the balance between supply and demand .

Corporate profits will improve thanks to swift layoffs early during the recession, and as demand picks up so will new hiring. None of this will happen overnight, but conditions will improve day by day. The economy is cyclical, the world is not coming to an end, this down cycle will end like they all do.

The negatives

They are all around you. With the press competing to quickly document the rush of bad news, layoff's, dwindling portfolios, foreclosures, lack of loans, collapses of the auto and financial industry, it is easy to see no end to the tunnel. If you want all the reasons why the economy will continue to collapse, pick up the daily news and keep reading.

The positives

The collapse in the price of oil and commodities will have an enormously positive impact on the entire economy. A decline in oil from $147 to $40 a barrel puts $125 a month in the pockets of the average consumer, money that goes towards consumption or debt reduction.

Corporate America is not sitting still. Massive layoff's, while painful for the consumer losing his job, will restore companies' profitability and contribute to a healthy economy.

Interest rates are near zero, and will stay there for several years as the government embarks on a large borrowing program to fund infrastructure investments. Low rates help consumers stay afloat by keeping credit cards and mortgage payments low, and incentivize businesses to invest.

The new admistration will hit the ground running and quickly invest in massive new infrastructure and alternative energy programs, determined to make us more competitive and create new jobs. As an example of what these can do for the job market, California's new high speed train initiative will create 450,000 jobs. If every state embarked on similar programs, over 4 million jobs would be created.

Stock valuations are low with forward-looking P/E ratios under 10, a number that by traditional measures leaves plenty of upside. A lot of cash is sitting on the sidelines, with the average American portfolio sporting a record 42% in cash funds. Once the fears subside and business conditions return to normal, this money will flow back into stocks and mutual funds to generate higher returns.

While all of this may take some time to show its way through the economy, it eventually will and is very good for America's future.

2009 predictions

1. The top 10 performing U.S. traded equities are Altria (Phillip Morris' parent), General Electric, Apple, Intel, Microsoft, Pfizer, Deere, Citigroup, FXI (China ETF) and Harvest Energy (Canadian oil trust).
2. The Dow hits bottom at 7,200 but finishes 2009 with a 20% gain.
3. Chrysler goes bust, GM downsizes, Ford turns the corner.
4. The U.S. dollar settles at $1.20 Euro.
5. Gold ends 2009 under $500 an ounce.
6. After reaching $30 a barrel and $1.25 a gallon at the pump, oil trades in a $50 to $75 a barrel range and stays there for several years, with supply and demand in sync.
7. Fed Funds rates stay near zero.
8. The bubble in treasuries and bonds bursts and yields return to normal.
9. Residential housing continues to depreciate; reaches bottom some time in late 2009, flat lines for a few years, and starts appreciating significantly in Spring 2013.
10. Lending returns to normal in the summer and mortgage rates stabilize between 4 and 5%.
11. China and Japan lead a worldwide stock market recovery.
12. Osama bin Laden is captured on a tip from someone in his inside circle.
13. The war in Iraq ends abruptly this Summer with a chaotic Vietnam-like exit, at which point the U.S. dollar starts rising.
14. The recession ends in September.
15. Unemployment peaks at 9.8% toward the end of the year.
16. And, according to my wife GayLyn, people will wear more colorful clothing to make themselves look and feel better, and alcohol consumption shall of course be on the rise.