Fear and Loathing in 2009

2009 is shaping up to make 2008 look like the good 'ole days... Why? Let's look at some issues...

STIMULUS: Won't it make a difference?
No. government stimulus is great in that it provides a nice immediate effect. It has a tremendous long term cost though. For the government to hire it must either take from others (more taxes) or just print money itself. Neither is a good option long term. It gives us all a warm fuzzy feeling in thinking that Barack is taking care of all of us but government jobs are never the answer. It is a credit card mentality from the government . It only works until the bill comes due....stimulating the private sector to create jobs is a far better option. It takes a bit longer to work, but the results, far from costing money provide it for all...

Let's reverse the whole scenario. What out there points to a recovery? A million jobs paving roads? Really? If the employment rate is expected to be 10% next year, then any jobs created by the government will be more than offset by losses in the private sector.

To use the credit card mentality again, the government will use its credit card to create demand [jobs] while at the same time losing income (from other job losses). Can you imagine how this scenario ends well? Me either..

HOUSING: A rebound?
Hell no!! Housing still has tremendous downside. Why? Housing inventory is still at 12 months and will only grow. The option arm nightmare is just beginning. These people cannot be helped by lower interest rates as they are not paying the minimum interest payment now on the loans. This is going to lead to another tidal wave of homes coming onto the market in the next year or two. Unlike the subprime defaults, these defaults will hit the $500k and over homes that people bought with 5% or less down. The already squeezed middle class is going to get whacked again...

A scenario in which we see 14 or 15 months of inventory out there is not all that out of the realm of probability.

Much has been said about the banks not lending the TARP money. They aren't because they know they have hundreds of billions of dollars of losses coming up in mortgage products from these loans coming up. They'll need the cash.

20% down...
The last two years of the housing boom were fueled by new mortgage products that allowed buyers to put in most cases less than 10% down for a home. These loans are gone. We are back to the 20% down rule. Where is it coming from? Investments? With the Dow (.DJI) and S&P (.INX) off 40% this year, the stock market will not be a source of funds.

Jobs? Unemployment will most likely hit 10% next year so it will not be from jobs or signing bonuses and people worried about losing a job are not going to tap savings for a new home. In short, there is not a source of funds for a down-payment.

Even if we have willing buyers, where are they going to get the money?

After the last housing bust in the early 1990s, it took 9 years for home prices to return to pre-bust levels. The boom then was nothing like the current one, so to expect prices to return and make millions of underwater home owners profitable when they sell anytime before 2017 is delusional.

INFLATION: Up, Up and Away
What happens when the supply of something grows unrestrained? Its value falls. Thus is the dollar. As its value falls, more of them are required to purchase items. Inflation ensues. How do we stop inflation? Raise interest rates to increase demand for dollars. Oops, there goes the housing fix currently being attempted...

THE CONSUMER:
Retrenching......If you have watched the news in the past month, shopper after shopper is saying they are cutting back on spending and not using credit. That is the right decision for them, but bad for growth today. The consumer is shell shocked and will not dip their toes in the water again until they are 100% sure it is safe. That will be a while. A poor economic climate in 2009 will only worsen the mood and the fear they feel, causing further retrenchment.

Part of this problem is the inevitable mood swing surrounding a new administration. This does have a severe downside though. "Hope" was Obama's message and the "it is a new day" mantra has been restated over and over by followers. Here is the problem, even if Obama does everything right, 2009 will still be a lousy year. That optimism will turn to a vicious pessimism as consumers will then resort to a "if he can't help us no one can" mentality.

The consumer will stash money away, reduce debt and live less frivolously. Again, all good things long term but very bad short term for business.

What to buy?
Personally if you are going into stocks, buy things people have to have with a nice dividend. Discretionary names ought to suffer as a whole with some individual spectacular successes.

Personally I am looking at oil (DBO), (DXO), shorting the dollar (UDN) and gold (GLD).

Not thinking about selling current holding as ones like Dow Chemical (DOW), GE (GE), Phillip Morris International (PM) all will pay me 9%, 7% and 6% in dividends this year (long term holdings so lower tax rate than regular income). Those that don't are smaller portions of holdings and success there ought to be met with very nice upside (hopefully).

AutoNation (AN) is capturing market share by the boat load as competitors close. It will emerge as the clear dominant player in all its markets. That, and I am still convinced something is going to happen with it, Sears Holdings (SHLD) and AutoZone (AZO).

Borders (BGP) is feast or famine. I think it will be fine but it will take time...CEO George Jones is doing everything right and Ackman will buy it before he lets it fold.

On the fence for a sell is Wells Fargo (WFC). It is a tough one because there are only really four big banks left (JP Morgan (JPM), Bank of America (BAC), Wells and Citigroup (C)) so business will be there. But, the level of business going forward just will not be there as housing suffers for years. I have been selling covered calls on it for three months now and have lowered my cost basis on it 10%. After January expiration, assuming a market rally going into inauguration, I may just take that chance to get out before the 2009 slide begins. If I am called out, my total return in it for the three months will be 12% (dividend included). I'll take it.

Disclosure: I hold positions in DOW, GE, PM, AN, AZO, SHLD, BGP, WFC

Comments

[investor88:]

A rough ride for 2009 it seems.

2008 Dec 24 11:51 AM

[helplessobs...:]

Todd,
I think your clear thinking is on the mark for 2009-2010. Most investors do not know we entered a secular bear market in 2000. The Oct. 2007 high on the SP is the end of a cyclical bull market within this bear. Secular bull and bear markets last a long time often 15 to 20 years, witness the last secular bear from 1966 to 1982 and the secular bull from 1982 to 2000.

2008 Dec 24 11:53 AM

[bookseller ...:]

Mr. Sullivan, how can a responsible journalist write:"Borders (BGP) is feast or famine. I think it will be fine but it will take time...CEO George Jones is doing everything right and Ackman will buy it before he lets it fold."

How will it be fine? Its market cap is now hover in the $20 million arena, the debt is increasing, its website isn't performing, inventory in stores is too low, sales are terrible, the company has no strategic plan, it has sacrificed valuable employees.

What is George Jones doing right? The problems may not be entirely his fault, but the ompany was moving in a positive direction when he took over and he failed to capitalize on one single strategic plan. On can partially blame "the economy," but, again, Jones had his chance.

Ackman made a bad investment and he will wind up with a company that will have to completely re-invent itself to survive.

Borders has effectively taken itself out of the CD and DVD markets and has drastically cut back on its book backlist.

What is the advantage of a book superstore over Walmart, Best Buy, Costco? The depth of its stock, the knowledge of its employees and the atmosphere it creates.

Borders had all that, but it is gone. It has given the backstock business to Amazon, the besteseller business to Walmart, Target, Best Buy, Costco.

It has lost many experienced, knowledgeable employees.

Th atmosphere now resembles that of a Dollar Store.

It has had its opportunities. It has had the Sony Reader for over a year and never did a single thing to market it. It is probably a better product than the Kimble and has the advantage over Amazon where the customer can go into a store and try it out. Now it is sharing th market with Target and Sams Club.

Mr. Sullivan, if you were Mr. Ackman, how would you turn around Borders? The Concept Store is a pipe dream. They may look nice, but they are not going to increase sales per square foot over the old days. Why will people go into a store to download anything when they an sit at home and do it? Why would a company invest in bricks and mortar when they can sell downloads from a website?

The ultimate question Mr. Sullivan is how much credibility do you have left? You do not provide specifics for anything. We are supposed to take you at your word that you are an all-knowing, all-seeing deity and we are supposed to trust you?

Are you still buying BGP? How much do you own? What are you going to do? Since you lack any specifis in your writing at least give us some transparency in your actions.

2008 Dec 24 01:23 PM

[whisperonth...:]

With the economy on the brink of ruin, today's word is return. We want a return on our investment too, and the banks want people to start using them again. 50 years ago, the banks had interest bearing savings accounts with an interest rate comparable to our CDs today. 3 and 4% were normal, and everyone put money into savings accounts. The banks were happy, the people were happy, the borrowers were happy. Now, those same depositors are not getting that kind of interest unless they have buckets of money in those banks. Since most of us don't even own a bucket, we're pushed aside. Our choice is to put that money into a CD and pay a penalty if we have an emergency. Isn't using the money and losing the interest enough of a penalty? Clearly not.

So we turned to dividends, and most of us look for a minimum of 4%, and the companies that give those kinds of dividends seem to be weathering the storm better than those that do not. A piece of advice for the banks - start offering 4% interest on a savings account, with a minimum of 60 days in the account. This is less time than quarterly stocks, less time than CDs, and will encourage people to begin saving again. Better yet, offer 3% for savings under $100.00, 3.5% for $101 - $500, 4% for $500 - $1000, and maybe 4.25% up to $5000. People will begin to invest in the banks again, the banks will get stronger, people will be more confident, and the rest will follow.

CDs aren't bad, and those of us who like them can continue to use them - perhaps the short term ones can be phased out and the long term ones be increased? Just because CDs work, that doesn't mean it's the only thing that works. Saving is a benefit to all of us, and it's better when we have a good reason to do it. Maybe 2009 wouldn't be so bad after all.

2008 Dec 24 01:51 PM

[whisperonth...:]

Another thought - the banks could even offer 1% for the first 30 days, 2% for the next 30 days, 3% for up to 90 days, and then go from there in .25% increments. Or .1% increments. But give us an incentive to start putting our money in banks - the current interest rates on savings aren't worth the time.


On Dec 24 01:51 PM whisperonthewind wrote:

> With the economy on the brink of ruin, today's word is return. We
> want a return on our investment too, and the banks want people to
> start using them again. 50 years ago, the banks had interest bearing
> savings accounts with an interest rate comparable to our CDs today.
> 3 and 4% were normal, and everyone put money into savings accounts.
> The banks were happy, the people were happy, the borrowers were happy.
> Now, those same depositors are not getting that kind of interest
> unless they have buckets of money in those banks. Since most of
> us don't even own a bucket, we're pushed aside. Our choice is to
> put that money into a CD and pay a penalty if we have an emergency.
> Isn't using the money and losing the interest enough of a penalty?
> Clearly not.
>
> So we turned to dividends, and most of us look for a minimum of 4%,
> and the companies that give those kinds of dividends seem to be weathering
> the storm better than those that do not. A piece of advice for the
> banks - start offering 4% interest on a savings account, with a minimum
> of 60 days in the account. This is less time than quarterly stocks,
> less time than CDs, and will encourage people to begin saving again.
> Better yet, offer 3% for savings under $100.00, 3.5% for $101 - $500,
> 4% for $500 - $1000, and maybe 4.25% up to $5000. People will begin
> to invest in the banks again, the banks will get stronger, people
> will be more confident, and the rest will follow.
>
> CDs aren't bad, and those of us who like them can continue to use
> them - perhaps the short term ones can be phased out and the long
> term ones be increased? Just because CDs work, that doesn't mean
> it's the only thing that works. Saving is a benefit to all of us,
> and it's better when we have a good reason to do it. Maybe 2009
> wouldn't be so bad after all.

2008 Dec 24 01:55 PM

[fatcat:]

Good article by Todd...and thanks for giving your investments in detail.I don't agree with all of them,but its refreshing that you weren't humping your book....Merry Christmas,all...

2008 Dec 24 04:21 PM

[Anthony Alfidi:]

You are pretty much on the mark, especially regarding Wells Fargo. A lot of bank problems we thought were solved in 2008 will look a lot worse in 2009 as option ARM resets destroy bank balance sheets all over again.

2008 Dec 24 05:21 PM

[Kunst:]

"What happens when the supply of something grows unrestrained? Its value falls. Thus is the dollar. As its value falls, more of them are required to purchase items. Inflation ensues. How do we stop inflation? Raise interest rates to increase demand for dollars. Oops, there goes the housing fix currently being attempted."

Well, that's traditional thinking, lack of which explains a lot of the mess we're in. Inflation is the end "solution" to this game. Inflation increases asset prices, such as houses and stocks, not to mention real stuff like oil and food.
The government will increase the money supply, effectively devaluing the dollar. Ultimately we will be poorer, but assets will sell again.

2008 Dec 24 05:37 PM

[E Nuff Sed:]

Wells-Fargo has already provided for 39 Billion losses on the 182 Billion mortgage book it has taken from Wachovia.

Looks like you are assuming losses will be a lot worse than that.

2008 Dec 24 09:41 PM

[araclaws:]

Mr. Sullivan,

You have brought up good points that the Pollyannas still cannot accept and are in denial. This cleansing process to realign the economy is sorely needed as we go through this hangover phase.

I also follow Peter Schiff and Jim Rodgers and they have said to focus on unimpaired assets, such as asian assets, commodities, and Gold as Dollar-denominated assets will suffer as the Dollar drops due to rampant inflation.

Most people say "What inflation". Well, this is a moving train that takes a bit to accelerate, but when it does, it will be also hard to stop.

2008 Dec 25 07:46 AM

[I should know:]

Todd,
Overall, good analogy of the upcoming market.

I have to agree with the below comment. Wells Fargo originated and purchased through wholesale, broker-in, and correspondent, ZERO Option Arm loans; NONE. They wouldn't do them. The senior managers did not think the loans were good for its customers or good for WFC.

True, they inherited a bunch with their Wachovia acquisition, but WFC already provided for $38 billion in Wachovia losses (after Wachovia ALREADY wrote-down billions on these loans). A $38 billion loss on $182 billion of mortgages "says" that 21% of these loans have NO value whatsoever, or 41% only have 50 cents on the dollar remaining. Even with the worse case forclosure on these types of loans, recapturing 50 cents on the dollar is a slam dunk. WFC will not come out unscathed, but they will be a strong survivor. The have the best senior management and a conservative lending mentality. Their loans are the highest performing in the industry. I panicked back in July and sold a bunch of their stock at $20.75 and have regretted it ever since. I wouldn't sell them short again.

**********************...

On Dec 24 09:41 PM E Nuff Sed wrote:

> Wells-Fargo has already provided for 39 Billion losses on the 182
> Billion mortgage book it has taken from Wachovia.
>
> Looks like you are assuming losses will be a lot worse than that.

2008 Dec 25 08:44 AM

[morph366:]

The real question with your prognosis has to do with the risks of inflation in the forseeable future and the over supply of dollars. All currencies are sibject to the same risk of over supply and with a race to the bottom the dollar can only come out as winner as it has the best "branding".
Check with any street vendors in a third world country and they will remind us that there is something reassuring about looking at pictures of George Washington et al on those bits of paper rather than some obscure symbol of European Union or Japanese emperors.

2008 Dec 25 08:50 AM

[tipalia:]

enjoyed reading your article, agreed with most of it. I hope you are right with SHLD but I don t share your view here and I hope I am wrong.One last
thing how can you short at the same time gold and the U.S dollar ? Something I do not understand here , would you be kind enough to explain your thought on these actions? I always thought that gold and U.S $ move in opposite direction.Thank you and Happy Hollidays to you and your loved ones.

2008 Dec 25 11:19 AM

[Jplout:]

Great article but dead wrong on Sears SHLD
"It will emerge as the clear dominant player in all its markets"
I have one word for you "SUPER-WALMART" Most of Sears locations are investor owned and these commercial loans are due for refinancing soon. Not going to happen. You can buy the same Junk at Walmart for less. Their appliance division is down substancialy. Their service went from AAA to atrocious. Sears at $38/share makes it a great target for shorting down to $5. Walmart at $55 makes more sense.

2008 Dec 25 11:19 AM

[User 30121:]

Lucid article.Thanks for writing it and sharing with us!

One pet peeve of mine is the phrase "government will CREATE jobs". I'm sorry, but the government DOES NOT CREATE JOBS. The government SHIFTS jobs, its TRUE!

If I'm full of it, enlighten me on an example of the government CREATING a job!

2008 Dec 25 02:27 PM

[Bobco23:]

if 2009 turns out as badly as you suggest, and I think it will, you certainly don't want to be in any of the stocks you recommend other than MO. GE capital and the dirth of business for capital goods wil be a big problem for GE. Even if GE maintains the dividend in 2009, the stock will sell down in anticipation of a 2010 cut and weak performance. DOW will face falling demand even though costs will decline. Margins will invert. Retail? Please.

Many stocks now offering attractive dividends will slash payouts as their businesses decline further in each succeeding quarter.

If you want to generate some relatively safe dividends look at the regulated electric utilities (FPL,SO for example), pipelines (ETP, MMP, KMP for example), consumer staples (such as PG and WMT), defense (GD, LMT), and some assorted compaines with strong competetive positions such as PM, LLY, and PEP. 2009 could be very bad for all the reasons cited.

2008 Dec 25 10:49 PM

[najdorf:]

Nonsense after nonsense. The original post makes no sense: nothing but bearish sentiment followed by sticking to positions that the writer is married to because he's facing huge losses on all of them.

whisperonthewind: Do you know anything about banking? Why would banks pay 4 or 5% for standard deposits that could depart any day when the government is essentially handing out free money? Are you that stupid? Many banks are issuing new mortgages at 5% and below - where do you think their interest margin is going to come from if they start paying equally high rates on deposits?

I should know: You already know that you were wrong once (driven and derided by greed in July - selling WFC for 20? What did you think, that we were never going to have any banks again? You should go into business as a contrarian indicator!). Now you're wrong again. WFC is not the First National Bank of Purple Unicorn-Land. They were in every type of bad lending - interest-only, subprime, Alt-A, HELOC, no-doc, ARM, etc. Maybe they didn't go as far into the joys of negative-am ARMs as Wachovia, but they remedied that mistake by purchasing them. Why would you trust any bank's marks when all of them have had to take further writedowns and loss reserves every quarter for the past year? Of course financial bulls will eventually be right, but it doesn't really matter if you're right about one bank (which you accidentally sold) 10 years from now when your other investments have blown up along the way.

2008 Dec 26 01:24 AM

[bonddude:]

Najjy- You're right, I'm sure, but wow you must have gotten some rotten xmas presents guy. I'm trying dxo for a bounce per chance at the open. What say you?

2008 Dec 26 03:56 AM

[NOWHEREMAN:]

Bernanke said: whatever it takes.

How much money do the States need collectively to keep their workers employed? How much do they need additionally to keep paying interest on their outstanding Municipals?

Anyone think the Fed will allow Defaults on Municipals?

If not, then a few of the CEF's like MHI should be worth looking into. 10% monthly Tax free payout, granted their financials are pretty opaque but "whatever it takes" will include them too. IMO

2008 Dec 27 01:14 AM

[E Nuff Sed:]

The internet was created by the government, the government sent a man to the moon and most of the bio-tech industry you see now was seeded by the government (through NHS research and equivalent in other countries). I can say the same about pharma, aviation, nano-technology. In times like these this is the role of government. Our crumbling infrastructure needs renewal and we need a huge push towards sustainable energy technology - a move towards solar and the hydrogen economy.

For life without government just look at Somalia. How would you like to live there?


On Dec 25 02:27 PM User 30121 wrote:

> Lucid article.Thanks for writing it and sharing with us!
>
> One pet peeve of mine is the phrase "government will CREATE jobs".
> I'm sorry, but the government DOES NOT CREATE JOBS. The government
> SHIFTS jobs, its TRUE!
>
> If I'm full of it, enlighten me on an example of the government CREATING
> a job!

2008 Dec 27 01:38 PM

[Trent Tucker:]

We may be in a recession but we are still in possession of our faculties. So why so many sane people in a recession? We know that while a rising tide floats all boats a tsunami is a different story. The tsunami formed when Ginnie Mae and Freddie Mac altered real estate and mortgage structure to allow 100% financing with no down payment, basically the same structure Wall Street uses when it speculates with other peoples money. So housing was turned into real estate gambling for anyone with a credit score above 700 and what is a true gamblers only discipline? No more money, a recession. The intent of Ginnie Mae and Freddie Mac was to allow access to housing for people who previously could not qualify and really they didn’t cause this. The speculators who figured out quickly how to gin the mortgage apps. and gambled on rising housing prices with multiple acquisitions caused this and Wall Street joined the fray because they were searching for a new investment frontier. You see, since the cold call cowboys fell off their horses they have been steadily losing their client base. The larger firms have been losing 15% of their client base annually for years. Previously marketing was able to replace them. The internet changed all that. Enter collateralized mortgages(The Glass Steagall Act had to be repealed to allow Wall Street access to mortgages. That happened in 1999). Surfs up, it is a tsunami mommy. A meltdown, fiscal fission, but where did it begin? It began when the rules were changed. (Actually it began when the brokerage firms began exploiting their clients to such extent they could no longer replace their dwindling client base and they had to search for happier hunting grounds) Now who really makes the rules? Our elected representative do. I have never been able to locate a recession or depression that was not caused by government intervention of some kind, or in the failure of governmental judgment. But was it a failure of judgment or bias? Of course bias is… monetary influence, lobbyist, powerbrokers, whatever you care to call them, I prefer money laundering. Tsunami’s occur because of an earthquake far away and this is no different. Change the rules, the earth shakes, the wave forms and the law of unintended consequences comes into play. So, again, where did it begin? Basically in in the backrooms of your, excuse me our, congressman’s office as the paid lobbyist of the largest financial firms exerted their influence over our elected representatives. It never changes, . when the eastern block was abandoned to Stalin the Polish summed up the situation the best, “Under capitalism man exploits man. Under socialism the reverse is true.”-Polish proverb author unknown. Of course in America many years later it depends on what your definition of is, is. This meltdown resulted because the brokerage firms were exploiting their clients to such an extent their client base began to diminish and marketing was bested by the internet and on line brokers. What to do? Finance a Senator and repeal Glass Steagall so Wall Street could collateralize with Main Street, and we have just recreated the same circumstances of 1929, which Glass Steagall was written to prevent. It took a few years but the tsunami has hit and the giants of finance in 2008 are being consumed by the wave they set in motion in 1999. It is the definition of unintended consequences and really, it is what the definition of is, is.
Trent Tucker Author Wall Street Dancers
www.strategicbookpubli....

2008 Dec 28 02:56 PM

[User 334614:]

Mr. Sullivan is right on with the future for the dollar. The backside to the infusion of dollars is inflation which ofcourse is not a problem now, but we all should skate to where the puck is going to be, not where it is now. So shorting the dollar makes perfect sense if it's a longterm short.

On housing with resets in the recent ARM's just starting, those woes won't subside; however, if lending rates can go down to the 4.5% the goverment wants then prices don't have to go down alot more. I do think they will still slide further anyway. On that note though, let me say all the speculation in housing the last few years was done with high prices and what seems like high borrowing costs in todays rate enviroment. So therefore with low low borrowing costs, low asking prices, it will become a great time to speculate in real estate in the future. The masses all follow the heard and assume what everbody is doing is the right thing to do. The time hasn't come yet, but realestate speculation will enter a golden oppertune time when the masses think it's the worst investment there is. When will that be? Maybe sometime in late 2009/10?

Jan 09 11:05 PM