Economic recovery is the pathway to restoration of wealth. Consumers have lost over $8 trillion of wealth to date. The vast majority of it was either in the equities market or housing prices.
Home Prices
It is unlikely housing prices will stabilize in the next few years. There has been an economic study done of the largest five financial crises in modern history. It concludes that housing prices will fall to 2003 levels. This means housing prices have another 15% to fall, and according to the results of this study – another two years for the bottom to be reached. .
I have written in the past on the need for the baby boomers to sell houses, and the hidden backlog of housing inventory – all which work against recovery. Lower interest rates should mitigate the situation somewhat, but it will not trigger a housing market recovery.
Equities Market – Weight of Money
Money needs to be engaged in a money making activity. The road to wealth building for most is not through labor, but investing money. There is a lot of money sitting on the sidelines in brokerage accounts, T-Bills, and other types of cash accounts. With ZIRP (zero interest rates), there is no way to build wealth with cash. Cash is just waiting to be invested in a wealth building stock market boom. This is the weight of money.
As there really is no viable wealth building investment vehicle for 2009, the premise is that the only place for all the money to go is the stock market. It is believed the need for rebuilding wealth will be so great that nothing will stop investors from flocking back to the market if just a little upward momentum can be created. Once the momentum begins, the weight of money will continue to keep the stock market surging ever higher.
There is just one tiny little problem with this scenario – corporate earnings.
We are in a world wide recession. Most businesses are contracting.
- Cutting workforce
- Absorbing losses on operations
- Consolidating business lines
- Terminating expansion plans
- Fighting for credit lines
- Absorbing costs of expansion which cannot be sold at this time
- Closing unprofitable units
- Selling or buying distressed companies
All of these activities expend existing cash. They are trying to get lean and mean to peak profits (or just survive) in this downturn.
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With the weight of corporate money plus the leverage of credit, these companies can begin to re-expand when economic conditions are appropriate. But the amount of leverage they can create is limited by their cash which has fallen to 2003 levels, and will reduce even more in the months to come.
The pumpers of equities like to point out that the market recovers approximately six months before economic recovery. I expect the downward spiral to end next year, and some tiny growth as we leave 2009. But it is difficult to project a scenario where corporate earnings will grow next year – or in early 2010. In the short term, changed conditions always work against earnings. Adapting to change costs money.
And will recovery return us to the business fundamentals of yesterday? Companies which decide to simply hunker down may be mis-positioned for tomorrow’s changed fundamentals. If there is a significant equities market recovery next year it will be based on smoke and mirrors – and not on future corporate profitability,
You need to be careful of equity and bond investments inside of 401(k). You cannot focus investments, and the opportunities of jumping in and out of the market are constrained.
Other Options……
I would be wary of any long investment opportunities because there are remaining downside shoes which have not fallen. Trading of gold, currencies, and stocks seem to be the only vehicles to potentially make money in 2009. Trading is not investing as you must keep your eye on the ball.
Disclosure: no positions
