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Tuesday, January 06, 2009 6:16 AM


Reflections On 2008, Themes For 2009


2008 may best be remembered as the year most would like to forget.

Sure there were some highlights that nearly everyone will remember fondly such as the opening ceremony of the Olympics in China, and for Democrats the election of Barrack Obama, the first black president in history, but otherwise there were slim pickings, especially on the economic side.

2008 brought a continuation of the housing crash, massive foreclosures, rising unemployment, the collapse of Bear Stearns, the bankruptcy of Lehman, a $700 billion bailout that most citizens were against, fear mongering by Bush and Paulson to get the bailout bill passed, a ponzi scheme right under the nose of the SEC by Madoff that wiped out as much as $50 billion, hundreds of mortgage lenders imploding, and a stock market crash that was down as much as 51% finishing the year at -38.5%.

We also witnessed a credit crunch, soaring corporate bond yields, a commodities boom and crash with oil soaring to $140 then falling to $36, record low yields in treasuries, the nationalization of Fannie Mae and Freddie Mac, and a bailout of AIG that has already cost taxpayers over $100 billion. Sadly, socialism was embraced while free market principles were shot and left for dead. Worldwide, the Fiscal Insanity Virus Spread Rampantly.

Finally, 2008 was a year of the biggest ever declines in the CPI, auto sales, consumer sentiment, home sales, home prices, and treasury yields which actually went negative on a couple of occasions. The only comparable period in US history to this sequence of events was the Great Depression.

Investmentwise (on the long side), treasuries were the big winner, followed by cash. Nearly everything else lost. I can sum all of the above paragraphs up in a single word.

DEFLATION

2008 is the year the impossible happened, the impossible being deflation. Deflation was called on this blog and a few other places but the idea was essentially mocked as impossible by the masses.

Of course this will start the inevitable argument about what deflation is or isn't, but what's described above is most assuredly an economic deflationary depression that only those clinging to impractical definitions can possibly disagree with.

For further discussion and a chart of conditions one would expect to see during periods of deflation, inflation, disinflation, and stagflation please see Humpty Dumpty On Inflation.

Themes For 2009

Looking ahead in 2009 here are some things I see as likely.

Obama will pass a stimulus package of $850+- billion but $300 billion will be "tax relief" amounting to $19 a week at most. $19 a week per household is not going to stimulate much of anything but it will add to the budget deficit. People will use that money to pay down bills, which is exactly what they should be doing with it.

The first 3-5 months are going to be extremely weak on the jobs front with 400,000 or more jobs lost each month. Obama is going to need to create 2-3 million jobs just to counteract job losses in first half of the year. There is no way he is going to create jobs that fast given implosions in state budgets and retailers.

In 2009 consumers will continue to retrench, housing will continue to decline, and as many as 100 small or regional banks will implode over falling commercial real estate prices. The Fed may arrange shotgun marriages with these banks instead of letting them go under.

I am sticking with a thesis that says we are currently in a sucker rally in the stock market that will end soon after inauguration or moments after Obama signs a new stimulus package. My target is 600 on the S&P but 450 is not out of the question. However, it is better to think of this in ranges and that range would roughly be 450-700.

It is quite possible the lows in treasury yields are in. Unlike 2008 where I was constantly beating the drums for lower yields, 2009 could be different. Here are the facts: 3 month and 6 month yields hit 0% and the 10 year came close to hitting 2%. Could there be lower yields still? Yes, quite easily. Is it worth playing for other than as a hedge or part of an overall investment strategy? No.

Should treasuries be shorted? No, it is too early. Yields can easily make lower lows. Just because something is not a good long, does not make it a good short. Look at how long yields stayed low in Japan. I doubt we see a print of 4 on the 10-year treasury for a long time. If one wants to bet on yields rising in a for a reflation trade, there are better plays such as going long energy stocks that yield a nice dividend as well.

What About Gold, The Dollar, Inflation?

Let's work backwards. One thing that is virtually guaranteed not to happen in 2009 is hyperinflation. So toss that silly hyperinflation ideas out of your head before they poison your mind. Credit marked to market is going to continue to plunge, and plunge at a faster rate than any stimulus from Obama or any swap-o-rama tactics by the Fed. In my book that is deflation. You might not be able to see it as the Fed will allow banks to hide the destruction of credit in level 3 assets or off the books in SIVs, but pretending something is worth more than it is does not make it so.

The Fed at some point will resort to out and out monetization, and that will have the inflationists screaming at the top of their lungs. However, banks will still be reluctant to lend, and consumers and businesses will be reluctant to borrow. In addition, I expect the velocity of money printed to be close to zero and for the savings rate to rise. In aggregate, these are not hyperinflationay things. Heck, they are not even inflationary things.

US Dollar Trading Range

Where the dollar goes will depend greatly on what foreign central banks do. Additional cuts by the ECB, BOE, and China will be dollar friendly. I expect those to happen. I am sticking with a thesis that has the dollar index in a trading range of 75-90 for most of the year. If Obama proves to be more fiscally prudent than the market participants think (this is quite possible because no prudence at all is expected), then the dollar can easily bust the top of that range. If the ECB refuses to cut in the face of an expanding recession, the dollar can fall to the bottom of that range.

It is highly unlikely the dollar crashes in 2009. The dollar already crashed. There is no other word for a plunge from 120 to 70 on the US dollar index. Furthermore, seignior currencies tend to strengthen in deflation and there is no reason to believe deflation will come to an abrupt end.

Wildcards

China is a wildcard, as is war in Mideast between Israel and Iran, as is protectionist legislation coming from Congress. On the positive side, pulling troops out of Iraq is likely dollar friendly. The rationale is spending money in the US where we at least get something out of it on the asset side of the balance sheet is better than wasting money dropping bombs. And finally it is possible that Obama makes peaceful overtures towards Iran, defusing a messy situation. This too would likely be dollar friendly.

Where's Gold Headed?

So where is gold headed in 2009? The answer is I do not know nor does anyone else. It is far easier to post solid reasons why S&P earnings will continue to fall, unemployment will continue to rise, and various stimuli will fail to stimulate than it is to predict the likelihood of various wildcards, actions by foreign central banks, etc., that may affect sentiment towards gold.

You may wish to consider buying some gold (not coins as the markup is ridiculous) and simply holding on to it for the long haul. Physical gold, stored outside the country, at GoldMoney is one of the best options. In the interest of full disclosure I have a relationship with GoldMoney and will benefit if you open up an account using the above link. It will not affect the price you pay when you buy or receive when you sell.

It is not possible to predict what timeframe it takes for market participants to realize it's not just the US dollar that is trash, but rather every fiat currency on the planet. That realization is a process, not an event that can be timed. So don't bet so much on it (or anything else for that matter) that you will lose sleep over it if price declines for a while longer.

Here's one final thought on equities: Expect the first half of 2009 to be a traders market, most likely biased to the downside, perhaps all the way through September. At that point (especially if downside S&P targets are reached), the final three months may provide a substantial 4th quarter rally. Whatever you do, don't marry this scenario or any other scenario. Be nimble, take the setups you see, and be happy with them.

Wishing you a happy and prosperous new year.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
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