Vass - Politics, Current events and more from an African American view

Saturday, July 12, 2008

Predicting the U.S. economy for 2nd half 2008 and 2009

Well how much fun are you having today? If you hold investments, it may not be a fun day at all.

Back in the 4th quarter of 2007 I said I believed the Dow Jones Industrial Index would hit 11,000. I thought this would be a move in the late 1st to 2nd quarter. I was wrong… on the timeframe. But this is not a pat yourself on the back kind of moment.

With Indy Mac having failed and fears rampant over whether Freddie Mac and/or Fannie Mae will follow there should be no doubt that the Dow will cross into the 10,800 area on Monday. Add crude oil prices that are continuing to rise on fears from Iran and you get a bad situation. But perhaps the real culprit for this current situation is the Fed (Federal Reserve).

The Fed has been providing banks extra money to ensure their solvency, but not requiring that loan reserves be increased. It’s kind of like stopping a leak in your tub by adding more water. The problem is not getting fixed and may get far worse. And all the panic about the mortgage industry seems to have done nothing but whip up polispeak from political candidates and political parties, each looking to sway voters.

Loan reserves must be raised at all financial institutions. That especially means Fannie Mae and Freddie Mac. And several institutions need to fail. That of course means that some people will lose their homes. Nothing can, or should be done about that.

When I some will lose their homes I don’t just mean the roughly 4% of homeowners that are in default. I include in that group those that will fail this winter due to the cost of heating oil increases. I expect that in total some 7% of homes are in danger of foreclosure this year. While it’s not a nice thing to say, they need to lose their homes for the economy to survive.

This is not unlike the enormous wash-out that occurred when the internet bubble broke in the stock market. Money was lost, as it should have been, and opportunities were created. Those that made bad financial decisions, whether corporate or individuals, lost and others benefited from that loss. It’s a standard cycle in the markets.

Of course what is likely to happen is that Congress (with it’s 9% approval rating – sure to go lower) will take taxpayer money and bailout homeowners and financial institutions alike. Thus more water will fill the leaky tub. Undoubtedly the current Administration will be blamed (even more than they should) and the war in Iraq (and possibly Afghanistan) will be identified as the cause of all these ills. Which is false.

The outcome will probably be a surge for Senator Obama, who prefers a bailout. This may lead to him being elected and higher taxes to pay for that bailout. And if anyone thinks a bailout of this size will be limited to just the top 1% of the nation they are insane.

I believe, looking at current factors several things are highly probable:

While each of these items may or may not happen they are all interrelated. I expect each item to happen, at least to the degree I stated, generally in the timeframe given.

As money tightens, gold will be a hedge and prices for all precious metals will soar again. Credit will get severely crunched, and credit card rates will fly. The debt load on the average American will increase from the current $6,000 to $8,500. Most of this increased debt will be from higher energy costs. Thousands of small businesses will shutdown.

As a result of all these things I expect that the Dow Jones will drop to 10,200 by December. If I am correct about Congress and Senator Obama – for the reasons stated – then I further expect a drop to 9,300 during 2009. A significant bear market indeed.

The main problem is that the solutions being looked at now raised taxes and increased liquidity, fail to resolve the actual problem. And the combination will weaken the dollar, to a point where holding U.S. bonds is unattractive. I won’t even mention the increase in retirees and Social Security.

But there is opportunity. I see the housing markets as a great buy, for those willing to hold for 5 years. Buys in the secondary city markets will probably do best having a lower purchase cost and holding value better.

Several financial stocks will be excellent buys. Some have far better balance sheets than others, but will be blasted by the same investor fears as those in bad shape. Companies like Citigroup are trouble spots as they reinsure their own loans and thus hide them better on the balance sheets. Financials will lead the markets down, but they also will signal the start back.

Coal will likely start to regain interest in the quest for alternative energy sources. I expect nuclear energy will also get a push, with at least 1 new nuclear plant being authorized to be built in 2009. I expect a call to switch to ethanol produced by grass and sugar to go initially unheeded until mid-2010. Further harming the ethanol push is the fact that there will be a glut of ethanol by mid-2009 through 2011.

Bond rates will be more attractive in 2009 than today with the likely increases in interest rates. Of course inflation rises will remove that benefit.

There may be other sources of opportunity but they will be guided by factors including but not limited to:

That is the outlook that I have based on what is currently ongoing in the world today. Some of this is just my on interpretation, some my deduction. But I believe that if only ½ of my expectations occur, the general outcomes as stated are accurate.

But look around and determine your own answers. Better to be prepared than taken by surprise.

Labels: Congress, Crude oil prices, Dow Jones Index, election 2008, ethanol, Federal Reserve, Freddie Mac, gold stocks, heating oil, real estate, Senator Barack Obama, stock market

Tuesday, November 27, 2007

Thoughts on the economic outlook of early 2008

Well now that everyone has finished the turkey (minus a few leftover sandwiches), let it digest, and worked off the extra weight running around shopping at every store with a discount sale it’s time of me to get back to work. There has been a lot worth writing about, but let me start with a simple thought. The economy.

The economy is perhaps not the simple part of the thought. It has far too many factors involved, and minds far greater than mine have debated endlessly about what will and does make it move up and down. But as a man who pays attention to the events and has a decent hold on current events I’ll throw my 2 cents in.

I had a friend recently ask me what I thought would be happening to the economy, and my answer was it’s going to get bad. Perhaps recession bad. And I added that the current group of Democratic candidates may only make it worse.

I say this because of several factors. Not the least of which are, the housing crisis, the financial sector, the cost of oil, and potential tax ramifications based on the current plans announced by candidates.

Let’s look at the housing crisis. While there are estimates that state the maximum reach of the crisis is on 5% of homes, I think it fails to take a couple of things into account. While only 5% of home mortgages have failed now, I would expect these are the early defaulters. I would guess that there are another 10-15% of homes in danger of default. Given that the Fed has lowered rates, these homes on the edge have gotten a bit of extra time, but that does not fix their problem.

This leads us to the financial sector. Already several major banks are claiming huge losses due to the bad loans they have made. In order to recoup their losses and in hopes of preventing more credit is being crunched. This means that large- and mid-sized corporations will have less capital available to them, and some short-term loans may be called or canceled. That does nothing to stimulate growth. Plus variable loans to the riskier ventures will invariably go up to offset the losses in the home sector. Thus the purchase of houses must slow, the real estate markets will cease top be a haven for a while and money will have to flow into new areas for investment.

Now when you consider that the corporations are getting higher cost for loans, or being denied, this is happening at the same time that costs for fuel are going up. A lot. That hits profit centers fast. Thus profit margins shrink at the same time that retail is hitting its greatest need for the annual shopping rush of the holidays.

Keep in mind that small companies will be cut off from loans by banks since their credit and assets are too weak in a tight credit market. Add the higher cost of transportation and several small companies will fail to make it thru the end of the year, I expect. That will hit all the businesses that supply and help them operate.

Also keep in mind that as I recall the market virtually never rises, or even maintains its level without the positive performance of the financial sector. As I mentioned that sector is already failing. As the dominoes fall I expect them to perform worse near term. Thus that is direct downward pressure on the market. And while the holiday sales will help retailers absorb the cost of higher fuel, the consumer will likely spend less (or buy items with greater discounts) because the cost of heating their homes and electricity and mortgages are all up.

What’s the last piece of this puzzle? The Presidential race. We have a critical election where several nation defining events will occur. Already several Democratic candidates have expressed expanding entitlement programs. Those programs, like nationalized healthcare, must be paid for via taxes. Those taxes will come from companies making less profit and citizens with less discretionary income. (And a bailout of the mortgage crisis costs even more that needs to me recouped from taxes) This is beyond the fact that when Democratic candidates are elected (which could happen in 2008 – which is a bad thought) the markets normally react poorly initially, when looked at historically.

Add all that up and you have a stagnating market, with reduced sales, higher costs, shrinking profit margins, higher taxes, horrible bond rates, and depressed real estate values. I call that a real problem. Especially if the tight credit, higher fuel costs, and higher taxes cause more home mortgages to fail than just the 15% low-end estimate I posed earlier.

What’s the best plan? Well I used to tell my clients (back when I was a broker, years ago) that we can assume these events as facts and plan for the worse. Set up a plan to sit and wait for a couple of the trends to reverse, and take advantage of market overreactions where possible (the market is more emotional than fact driven even in the best of markets). Is that the best plan for you? I have no idea.

Discuss this with your financial professionals, read what better minds than I say, and make up your own mind. Just remember, it’s all connected, and there is never a perfect answer.

** This can also be seen at Economist Blog where I am an occassional contributing author.**

Labels: credit market, Democratic Party, election 2008, financial sector, heating oil, holiday retail sales, mortgage loans, Presidential race, real estate, stock market