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THE WINTER OF OUR DISCONTENT By Mike Gasior It took me almost nine years to quote Steinbeck, but no other title better suits the mood that the economy leaves me in. Since this is the year-end edition of my newsletter, where I annually make predictions for the coming year and review last year's forecasts, I will try to make that my focus and avoid drifting off into any other nonsense. I am acutely aware that I didn’t make good on my resolution of last December, where I promised I would try hard to get back to my monthly schedule. Given that, this is the seventh edition I’ve written during the busiest year I’ve had in the last 20 and I’m truthfully quite pleased with myself. Since there is a lot to cover this month, let's get right to work. THE WEBSITE IS COMPLETE FOR 2009 I have been offering training to the institutional investor community for what will now be my 20th year, but this education may never have been as important as it is going into 2009. With the turmoil we have just endured and the confusion surrounding many of the assets held by investors, staffs need appropriate knowledge to operate in these conditions. With many organizations reducing headcounts in various departments, cutting back on education for the remaining personnel in this environment could be potentially catastrophic. We will be offering 21 of our most timely programs in New York, Los Angeles and Chicago during the year and you can view the entire schedule at the following link: http://www.afs-seminars.com/schedule.html We still have very nice dates available if your organization is interested in holding an in-house session for your staff or having me speak at your function. You can view our course catalog, which details all of our "standard" sessions at the below link. Please remember that we are also happy to create a custom program of topics that is perfectly tailored to your audience's needs at no extra cost. Here is the link for our course catalog: http://www.afs-seminars.com/documents/Catalog2009.pdf To inquire about either in-house seminars or speaking availability, please call my offices at (860)347-6568 or write us at info@afs-seminars.com MIKE IS A BLOGGER NOW For those of you who just can’t get enough of me in these semi-annual newsletters (kidding) I have decided to begin my own blog to augment the pearls of wisdom I share here. It will be a much less formal setting and while I can’t promise an entry every day, I plan to be fairly active so please stop by and take a look. Rather than predict what my format will be I think we should just let it evolve and see what we get. Your input is always welcome and anyone is welcome to respond to any post I make. You can find the blog at this link: MY OVERVIEW OF 2008 AND POINT OF VIEW TOWARD 2009 Before I get into my thoughts about the prospects for 2009 and beyond, I think it will be worth our while to reflect on the events we have already lived through in the prior 12 months and discuss what that means about the future. My guesses are no better than anyone else's, but I am also not "talking my book" since I have no horse in this race. I don't need stocks, bonds or commodities to go up or down in order to make my year. Consider this when listening to the talking head stooges on television who predict a rosy economic future is coming around the corner sometime very soon where these people work. If they work for an investment bank, mutual or hedge fund company, commercial bank or pension fund, you will have your answer. The financial system in 2008 experienced what is easily the worst crisis since the Depression of the 1930s. Although I got sick of listening to the blowhard politicians ranting in interviews during this episode, they were, for a change, not exaggerating. I still struggle to comprehend the number of financial institutions that were lost during the year. The ones that didn't simply fail were purchased at fire sale prices by stronger companies, or are now limping along due to huge infusions of cheap, taxpayer money. Almost all major stock indices around the world are down by between 40 and 50 percent from their 2007 levels. Credit spreads on almost every quality of borrower jumped to record levels. A liquidity and credit crunch like nothing that has been seen in almost 80 years is making it literally impossible for anyone to borrow money. The smaller, emerging-market economies around the world were so close to complete and utter failure, they had to ask for help from the International Monetary Fund. Iceland didn't make it at all. Then the entire global financial system had a heart attack after regulators decided to let Lehman Brothers fail, prompting massive policy responses like the passage of the TARP and intervention by the Federal Reserve in order to avoid a meltdown. What people are now wondering is whether the worst is over, or is more economic pain waiting in the wings for us during 2009. Some of you will not be at all surprised at my answer to this, but I sadly think the worst is yet to come. The entire world economy is going to continue contracting in what will be a severe and protracted U-shaped global recession that started almost exactly when I told you it would in early 2008. I have no doubt that the United States will absolutely experience the worst recession I have experienced in my half-century lifetime, a deep and protracted contraction of the economy that will easily last through the end of 2009. If a recovery were to actually begin in 2010 the economic growth will be so weak it is going to feel just as terrible as the recession did. You will hear commentators talking of economic growth, but you won't feel any. But the problem is far from isolated to the United States, and many regions will feel even more pain. There will be severe recessions also in the euro zone, the U.K., continental Europe, Canada, Japan and the every other industrial economy. In the emerging economies it will be even worse, since they rely on selling goods to the larger economies. Factory closings in China are already at epidemic levels. Among the so-called BRICs (Brazil, Russia, India and China) Russia is in the scariest position since they rely so heavily on oil sales. They will be in a very bad recession in 2009 and I suspect there may be a chance of another Russian default (the last was in 1998) should oil prices stay depressed. Some economists are predicting that growth in China will slow to 5 percent or less and I frankly think it could fall to zero quite easily. This presents an amazingly hard landing for a country that needs to have its economy growing at close to 10 percent to move 10 million to 15 million poor rural farmers into the urban industrial sector annually. It is hard to imagine Brazil growing much at all next year, and though India may fare the best of the four, they will experience a sharp slowdown themselves. The other emerging market economies will suffer a similar hard landing and this severe global recession will morph into something that very few Americans alive today have experience with: stag-deflation. This is the particularly deadly combination of economic stagnation/recession mixed with the deflation of prices across the board. In the advanced economies, with aggregate demand for goods and commodities falling below growing aggregate supply, this lack of purchasers will lead to deflationary pressures as companies’ pricing power is extremely restrained. To add insult to injury, the rising unemployment situation will keep labor costs and wage growth very low. These factors, combined with sharply falling commodity prices, will cause inflation in advanced economies to ease into negative territory (and there is already evidence that it might be underway), raising concerns about deflation. In my opinion our most serious threat at the moment is deflation. The reason that deflation is so dangerous and why Ben Bernanke is scared to death of it is because it renders Central Banks impotent. The Federal Reserve may already be in need of a Viagra with their recent rate cut to effectively zero. Nominal policy rates (the rate the Central Bank charges borrowers) can’t fall below zero, so monetary policy becomes ineffective since even zero is too high of a rate to borrow at when prices are in decline. Even all this quantitative easing the Fed has embarked on may not work either. Basically, to steal a poker analogy, the Fed has gone "all in" with their current monetary policy. The Federal Reserve has increased its balance sheet by over triple since this past summer with their aggressive lending and purchasing of bonds and other assets. Falling prices mean that the real cost of borrowing money at zero is still too high and any debt you are carrying becomes larger in proportion by the day. This will feed us toward even further declines in consumption and investment, which sets off the vicious circle where incomes and jobs are squeezed, aggravating the fall in demand and prices decline even more. Having watched the buffoonery in Washington, D.C. over the past 18 months it is also obvious that as traditional monetary policy becomes ineffective, other stupid and ineffective government policies will continue to be used. There will be plans to bail out investors, financial institutions, and borrowers. Perhaps even more massive providing of liquidity to banks in an effort to ease the continuing credit crunch. Even more radical actions may be taken to reduce long-term interest rates on government bonds and narrow the spread between market rates and government bonds. There is a variety of debate as to what caused all of this to happen. The common belief and the conventional wisdom is that today’s crisis was triggered by the collapse of the U.S. housing bubble, but it is much deeper and simpler than that. This problem was simply caused by what I've been preaching in this newsletter for years; and that was America’s credit excesses in every arena. Americans borrowed far, far too much in residential mortgages, commercial mortgages, credit cards, auto loans and student loans and the chickens have now come home to roost. To amplify and complicate the situation there were many other things that contributed to our current state besides consumers. There were also massive excesses in all of the securitized products that converted these debts into toxic financial derivatives; in borrowing by local governments; in financing for leveraged buyouts that should never have occurred; in corporate bonds that will suffer massive losses as defaults surge; in the dangerous and unregulated credit default swap market. All of these things helped to make a very bad situation into an extremely dire situation. To add even further to the situation, these excesses weren’t confined to just the U.S. during this time period. There were corresponding housing bubbles in many other countries, fueled by excessive and cheap lending that never accurately reflected the underlying risk being taken by the lender. This all fed into the commodities bubble and the exploding private-equity and hedge-funds bubbles. Another contributing factor to our future suffering was the rise of what we can call "shadow banks" in recent years. Currently underway is the demise of this "shadow banking" system, which is simply a complex of non-bank financial institutions that looked like and acted like banks during the previous five or so years, as they borrowed short term and in liquid ways, leveraged a lot, and invested into longer term, high yielding, but illiquid assets. As a result of all this, the biggest asset and credit bubble in financial history, including the tulip bulb bubble of the early 17th century is going bust. When all of this is said and done, there is a good chance the overall credit losses could ultimately be more than $2 trillion. Although it might already seem to taxpayers that the banks and others have already gotten far too much in the way of bailouts, until governments rapidly recapitalize financial institutions, the credit crunch will become even more severe as losses mount faster than the recapitalization can occur. The banks would be forced to even further constrain credit and lending. And, although equity prices and the values of other risky assets have plunged from their peaks of late 2007, there is still significant risk for more, and even substantial, further declines. In my estimation, there are FAR too many people that think that the prices of risky assets, including equities, have fallen so far that we are at the bottom and a rapid recovery may begin any day now. But during the first quarter of 2009 the various macroeconomic news; earnings and profits reports; the financial sector news from around the world will be far worse than expected. Another 20 percent decline in stock prices around the world is well within the realm of possiblity, and I'll go as far to say, probablity. Although it is true that the chances of a systemic financial meltdown have been reduced by the actions of the Group of Seven and other economies, severe vulnerabilities remain for all of these economies. I think that the credit crunch will persist for quite a bit longer and spread beyond mortgages. All sorts of deleveraging will continue in a variety of places, as thousands of hedge funds, many of which will close their doors shortly, and various other leveraged players will be forced to sell assets into illiquid and distressed markets. This will cause price declines and also drive more insolvent financial institutions out of business. Credit losses will continue to mount as the recession gets deeper and the FDIC will become the largest bank holding company in the U.S. Finally, a few emerging-market economies will certainly enter a full-blown financial crisis and may go down a very similar path as Iceland as the situation unwinds. So, in summary, 2009 will be another painful year with global recession and more financial stresses, losses and bankruptcies. If I were to be laying odds, the chance of an L-shaped, stag-deflation recession is now rising to a 1 in 3, while the likelihood of a severe U-shaped recession is 2 in 3. It will take amazingly aggressive, coordinated and effective policy actions by the advanced and emerging-market countries to ensure that the global economy starts to recover at all in 2010, but I'm not sure there is poltical capital available anymore to make that happen. If not, we are likely entering a more serious and protracted period of economic stagnation and one only need to ask Japan how hard those are to escape from. BEFORE I START MY SELF RIDICULE, LET’S LOOK AT OTHER GREAT PREDICTIONS I was a little off on some of my forecasts for last year, but reading the below list made me feel a little bit better. See what you think. --"A very powerful and durable rally is in the works. But it may need another couple of days to lift off. Hold the fort and keep the faith!" according to Richard Band, editor, Profitable Investing Letter, Mar. 27, 2008. At the time of the prediction, the Dow Jones industrial average was at 12,300. By late December it was at 8,500. --AIG "could have huge gains in the second quarter." said Bijan Moazami who is an analyst at Friedman, Billings, Ramsey on May 9, 2008. AIG wound up losing $5 billion in that quarter and $25 billion in the next. It was taken over in September by the U.S. government, which will spend or lend over $150 billion to keep it afloat. --"I think this is a case where Freddie Mac and Fannie Mae are fundamentally sound. They're not in danger of going under I think they are in good shape going forward." Proclaimed Barney Frank (D-Mass.), House Financial Services Committee chairman on July 14, 2008. Two months later, the government forced the mortgage giants into conservatorship and pledged to invest up to $100 billion in each. --"The market is in the process of correcting itself." Explained President George W. Bush, during a March 14, 2008 speech. Given that the Dow Jones Industrial Average finished at 11,951 that day in March, it appears that the market continues to correct and correct and correct. --"No! No! No! Bear Stearns is not in trouble." Jim Cramer of CNBC told his television audience on March 11, 2008. Five days later, JPMorgan Chase was basically forced to acquire Bear Stearns with almost total government help, nearly wiping out shareholders. Jim Cramer’s television show should not be allowed on TV for the damage he likely causes people that don’t realize they shouldn’t listen to almost anything he says. But that’s another newsletter. --"Existing-Home Sales to Trend Up in 2008" read a headline from the National Association of Realtors in a press release dated December 9, 2007. On Dec. 23, 2008, the same group said that November sales were running at an annual rate of 4.5 million, down 11% from a year earlier in the worst housing slump since the Depression. --"I think you'll see (oil prices at) $150 a barrel by the end of the year" predicted T. Boone Pickens on June 20, 2008. Oil was then around $135 a barrel. By late December it was below $40. I can’t say anything though; below you will see my prediction of $115. Since misery loves company, at least I wasn’t alone on this call. --"I expect there will be some failures. I don't anticipate any serious problems of that sort among the large internationally active banks that make up a very substantial part of our banking system." This comment from Ben Bernanke, Federal Reserve chairman February 28, 2008. In September, Washington Mutual became the largest financial institution in U.S. history to fail. Citigroup needed an even bigger rescue in November along with many other banks who were forced to take capital infusions whether they wanted them or not. --"In today's regulatory environment, it's virtually impossible to violate rules." According to Bernard Madoff, money manager on October 20, 2007 Enough said on this one. I’ll have to admit that this one is my favorite. 2008 PREDICTION RESULTS I will try to keep this as straightforward and to the point as possible. And although this was a VERY bad year for market and economic forecasters, before you pass harsh judgment on me, consider the following synopses: --I predicted the stock market would fall over
2,000 points and it fell 3,500. And while I totally botched the oil, yield curve and inflation calls, you’d better have confirmable proof that you did better than me before you write me some pathetic email telling me how wrong I was. If you want to pee in the tall grass with the big dogs, you’d better be laying yourself bare for all to see like I do. So here goes with the results. Dow Jones - Below 11,250. Right off the bat, I am going to give myself this one. The Dow was 13,264.82 when I made this prediction and damn near all of you thought I was insane for predicting more than a 2,000 point decline at that time. And in your hearts you all knew I was actually even more pessimistic than my prediction conveyed too. I’ll admit I didn’t envision 8,000, but I’m not very surprised at all. NASDAQ - Right near 2,000. I repeat my comments on my Dow Jones prediction. Ten-Year Treasury Note - Falling to 3.75% With the ten-year yielding 4.05% when I made the prediction last year, I was forecasting a 30 basis point decline in rates. While I was right about the direction, I could have never envisioned the level of catastrophe that overwhelmed the U.S. economy. The idea of 0% yields on short term Treasuries is a nightmare scenario that Japan can teach us a lot about. Fed Funds Rate - 3.25%. The Fed Funds rate was 4.75% last year-end and I was forecasting a 1.50% decline and was almost alone in that prediction. I think I did okay. You go find some other major, economic figure that predicted 0% and you can then send me a gasbag email about how wrong I was. Yield Curve - Very little change in shape from
year-end 2007 to 2008 but probably a bit flatter. A pretty bad miss here. I expected rates to decline, but I never expected short Treasury Bills to yield zero either. Make sure you find someone who did before you write me on this one too. The Economy - Can you say "recession".
GDP growth will have stopped growing no later than the second quarter.
Frankly, I think it already has. Enough said. But each of you should have to send me $1.00 for this one alone. Real Estate - Residential market weakening considerably
more and the commercial segment becoming softer throughout the year
as the economy weakens. Residential should start finding the bottom
by the very end of 2008 and no later than mid-2009. Since my prediction encompasses 2009 here, there is still more to find out, but I like my odds. I’ll admit that I think I’m totally wrong on residential bottoming at the very end of 2008 and probably even anytime in 2009. Oil Prices - Oil will stay continually above $80
and will close at $115. This is a complete train wreck and would have looked even worse had oil not climbed $4 on the last trading day of the year. And there is more to come. U.S. Unemployment - Rising continually throughout
the year to finish at 5.8%. Unemployment was 5.0% at year-end 2007. I don’t feel too bad here. U.S. Inflation - CPI for the year at 3.9%. Can
you say "stagflation"? I was lucky to even get this close, since oil and other commodities dropped like a stone late in 2008, turning the CPI number negative for the last few months. I certainly didn’t see that coming. The U.S. Dollar - Will weaken somewhat more and
then find a bottom in the third quarter. I estimate more than 80%
of the move downward has occurred by now. Very little move downward
is left but there will be no real upward move. I’m not sure I can land a prediction closer. Allow me a moment to feel smug. Okay…thank you. Business Travel - I have been on the road almost
continuously for 20 years and 2007 was the most expensive I can
ever recall. Expect the cost of airline tickets, hotel rooms, rental
cars and everything else associated with travel to increase in 2008. And being pretty much dead-on with this prediction was a particular nightmare for me. Because of what non-U.S. travelers were willing to pay, I didn’t spend a single night in my beloved Waldorf Astoria since I’m basically too cheap. Perhaps 2009 is my year for bargains. 2009 PREDICTIONS INCLUDING A COUPLE NEW ITEMS Dow Jones –Right around 8,000 with a move to nearly 6,000 during the year. NASDAQ - Right near 1,500 after a move that gets very close to 1,000. Ten-Year Treasury Note – Falling below 2.00% quickly in 2009 and staying below. Fed Funds Rate – 0.00%. Yield Curve – Only a little flatter. Short
rates near zero and the 30-year getting to around 2.25% Real Estate - Residential market weakening considerably more and the commercial segment becoming softer throughout the year as the economy weakens. Residential may start finding the bottom by the very end of 2009 but maybe not. Commercial real estate will fare even worse. Oil Prices – Oil finishes near $25 and stays between $35 and $20 for the year. U.S. Unemployment - Rising continually throughout the year to finish at 8.7%. U.S. Inflation – Less than zero. Deflation. The U.S. Dollar – The dollar will remain relatively strong in early 2009 but begin to weaken as the U.S. government issues more and more debt. Year-end 2009 will show the dollar weaker than year-end 2008. YOUR DECEMBER BRAINTEASER This brainteaser is a pretty high-protein, low-fat serving to be dishing up to you for a year-end quiz but I will be impressed at anyone who actually gets it without peeking. I think it might be guessable, but I’ll be more impressed if you can explain the logic that is behind thee answer. It is a total departure from many of my past offerings and pretty darn tough, so don't pull any muscles. Here it is: "A line of 100 airline passengers is waiting to board a plane. They each hold a ticket to one of the 100 seats on that flight. (For convenience, let's say that the Nth passenger in line has a ticket for the seat number N.) Unfortunately, the first person in line is crazy, and will ignore the seat number on their ticket, picking a random seat to occupy. All of the other passengers are quite normal, and will go to their proper seat unless it is already occupied. If it is occupied, they will then find a free seat to sit in, at random. What is the probability that the last (100th) person to board the plane will sit in their proper seat (#100)?" Give it a good try before caving in and peeking early, but when you want to view the answer you can do so at the following link: http://www.afs-seminars.com/brainteaser_Dec2008.html Copyright 2008, Michael Gasior. All Rights Reserved AFS Seminars LLC |
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December 2008 Newsletter
