12 Reasons Stocks Will Decline in 2009 12 comments
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October: This is one of the peculiarly dangerous months to speculate in stocks. The others are July, January, September, April, November, May, March, June, December, August and February. ~Mark Twain
While there is much to celebrate this year, we find little cause for joy when looking at the financial markets. While many pundits have predicted that the final closing low in the bear market was reached on November 20th, we at Hurricane Capital Global Alpha Fund still believe there will be more red than green in the stock market in 2009.
However, during every major bear market since World War II, the time to buy stocks was after a 30-50% decline in the S&P 500. So one may ask why we would recommend something different this time around. In the spirit of Christmas, we present twelve reasons why there is more downside to the stock market in 2009.
1. Valuation: Historically the price to earnings ratio (P/E) and price to book ratio (P/B) of a stock or index is considered cheap when trading at less than ten to one and one to one respectively. Stocks in the US bottomed with at a P/E of 7 in July 1982. During the Great Depression, Benjamin Graham wrote about how many of the greatest US companies would be worth more if liquidated for the cash on their balance sheets than kept. These stocks were trading below their net current assets.
According to Bloomberg, the Russell 3000, which incorporates 98% of the market cap of us stocks, has a trailing P/E of 24.64 and a P/B of 1.68. Despite the massive drop that occurred in 2008, it would be tough to characterize the market as cheap from a historical perspective.
2. Housing Prices Crashing: The latest monthly reading of the Case-Shiller home price index from October 2008 showed a drop of 18.04% year over year, the largest drop on record. Amazingly, the drop in home prices is still accelerating two years into the decline. We are not going to find a bottom in the market until the pace of decline slows significantly. The massive tailwind the US consumer had been receiving from equity extractions has officially ended.
3. Debt Destruction: American consumers doubled household debt this decade while incomes stagnated. Consumers adding a trillion dollars in debt ever year on average for the first 7 years of the decade. Two trillion in consumer credit lines may be pulled in 2009, and home equity extractions are done for the foreseeable future. Another way to look at this is consumers would have a trillion dollar pullback in spending from 2007 levels if debt stops expanding. Debt destruction, which we believe is going to occur, means purchases would have to decline by over a trillion dollars. This would mark the first significant destruction of debt in the US since the 1930s. Growth of household debt to GDP did not start increasing again, until after World War II, over a decade later.
4. More Writedowns: We have another trillion or so of losses to take in the commercial real estate, jumbo mortgage, prime mortgage, leveraged loans, asset backed, corporate bond and credit default swap markets. This is assuming subprime and Alt-A are now priced correctly. On second thought, considering the debt destruction process, it could be more like 1.5 trillion.
5. US Corporate Earnings Collapse: Corporate earnings estimates are way too high. The consumer is dead due to the debt destruction, and there is another trillion (give or take) in losses yet to be realized across the financial sector. Almost all earnings growth in the first half of 2008 came from oil, basic materials and technology. Pricing has collapsed in all three areas. We have not yet seen the price collapse reflected in the EPS of companies in these industries. We will see it in 2009. Be wary of people touting cheap stocks based on future earnings. Trailing twelve month earnings on the S&P are $44.91 a share. The average analyst estimate on Bloomberg for the S&P 500 is currently $71.69 per share for 2009. There is absolutely no way companies will earn more in 2009 than in 2008. None.
6. Corporate Credit: Credit spreads are at levels where companies cannot fund themselves and survive. This is if companies can roll their debt at all. Much of the lending during the last 5 years was never meant to be paid back. Spreads on CCC bonds hit 40% in December. There are loan sharks who charge better rates than this. The debt markets are still closed for virtually everything high yield.
7. 12.5% Underemployment: And rising fast.
8. No Savings: The savings rate was under 2% from 2005-2007. Interest rates were low, and lots of spare money was funneled into the stock market. It always goes up if you buy and hold. Right? This was conventional thinking anyway. Many people now need this money to live on. This means further withdrawals from the stock market. Cash is once again king. The savings rate increased from 0% in early 2008 to 2.4% as of today. This rate was over 10% for much of the 1970s and early 1980s, and it needs to go higher. It will come from the stock market as well as from a pullback in spending.
9. Global Savings Trough: Helicopter Ben said that a global savings glut primarily in China, Russia and the Middle East caused money to pour into treasuries and other financial instruments of dubious merit throughout the decade. China’s manufacturing sector is now in contraction, and Japan is in a full blown recession. The world’s major commodity exporters (Australia, Brazil, Russia, and OPEC) are now facing huge budget deficits at home. Russia has already spent over 100 billion trying to defend its currency. Those who were counting on sovereign wealth funds and foreign government to buy US assets in ever increasing numbers will find these counties have more pressing uses for the money at home.
10. Helicopter Ben: While trying to debase the dollar may give asset prices a temporary boost, we believe debasing the currency is not the road to prosperity. If the Bernanke is hell-bent on creating more dollars he will eventually succeed as debt destruction ends. The US was a net exporter in the 1930s, much like China today and Japan in the 1990s. We believe it is easier to create inflation in a country that is a net importer, than a country that is a net exporter.
There is however a small problem with this strategy. Not only can US citizens buy foreign assets and currency, but foreigners can sell their US assets. Both will be problems if the US continues to undertake a strategy of quantitative easing. Foreigners will sell US assets if they believe that the currency will weaken dramatically. Foreign holdings of US debt and equity increased from 4.338 trillion in June 2002 to 10.591 trillion in June of 2008. Things have changed since this June though. Foreigners have net sold 26 billion of US securities in the July –October 2008 period vs. 182 billion in net purchases in the July-October 2007 period. Could there be a race to debase currencies around the world that makes this irrelevant? Of course. What would happen if foreigners lose faith in the dollar, sparking 10 trillion dollars in debt and equity sales? Don’t ask.
11. Bernie Madoff: There are hundreds of billions of assets still invested in fund of funds. These funds take a large fees for supposedly performing due diligence, and opening up investors to profitable strategies that they would not otherwise have access to. 99% of them are losing money this year. Fund of Funds make up over 40% of hedge fund assets. Billions of fund of funds money was invested with Bernie Madoff. Had these fund of funds done their job properly he never would have got a penny. Anyone who had looked into the auditing firm, a one man shop in a 13 by 18 foot office, would have known not to invest. Many are questioning if fund of funds add any value at all, or just another layer of fees. A long shadow hangs over the entire fund of funds industry, and massive outflows will continue in 2009.
12. Hedge Funds: The top 100 funds make up approximately 75% of total hedge fund assets. Over 90% of hedge funds have lost money this year, and you can count the big winners on one hand. A number of funds have halted withdrawals because so many people wanted their money back at once. People who need the money invested in hedge funds that don’t ask for it now may be prevented from withdrawing for the foreseeable future. Half the hedge fund industry is going to disappear by the end of 2009, and Fund of funds are going to exacerbate the already massive problem the hedge fund industry already faces.
The market in 2009 is going to break people’s spirits, as even the patient investors who waited are going to lose money in bear market that seems to go on forever. Those who waited for the drop before buying will get crushed just like those who were in at the top. Volatility will continue, and the trend will be down. The downtrend will be interrupted by periodic bear market rallies lasting a few weeks to a few months. These bear market rallies will trick people into believing the bottom is in. We are in one of these rallies now.
Remember that the worst is yet to come for the economy and the market, and you will remain solvent for a happy holiday in 2009.
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One last look at 2008 will reveal a very weak fourth quarter with GDP growth contracting -6%, in the wake of a sharp fall in personal consumption and private domestic investments. We see the real GDP growth contraction playing out through the year as follows: Q1 2009 -5%; Q2 2009 -4%; Q3 2009. -2.5%; Q4 2009 -1%, adding up to a yearly real GDP growth of -3.4% for the U.S. in 2009.
All of this has profound implications for the broader market and it is hard to make a case for a second half recovery when the economy is still tanking. Toward the end of this year trailing twelve month earnings for the SP500 could be in the $ 40 range. A mutiple of 15 would yield an SP500 of 600 while a multiple of 20 offer 800.
The November low at closing was 752 and we closed yesterday at 906. Given the likely economic climate and the nature of the bottoming process, I think 740 will be tested and breached in the first half.
who cares qhat the S&p or the dow will do, or the R2k, for that matter? All your valuation concerns are fine but the conclusions are somewhat odd. there are plenty of stocks with real assets , valuable assets, great cash flow trading at p/B of 1 or much less than 1 and with p/Es of 10, 8, 6, or even 3. That leaves a huge margin of safety even in case of a sharp decline in profits!
a final comment: all stands and falls with credit markets. if they can be unfrozen sooner rather than later, the recession might end quciker and turn out to be much less severe than most people think right now. if credit markets remain frozen for another year, well, then the stock market certainly has another 50% downside from here. The indexes, that is. but a boatload of satocks out there doesn't have much of a downside even then anymore.
Data here: www.federalreserve.gov...
www.census.gov/compend...
Table 1152
A far more honest statistic than "unemployment," but a tricky can of worms even so, since "underemployment" mixes those folks forced to settle for a lower quality job than they could handle with those folks who desire part time work for other reasons (esp. dual income households where one spouse prefers to work part-time at home).
In any event, I'd expect "household income" to stabilize or rise in the next decade, but it will do so for the same reasons "family incomes" rose in the 80s: more people in the household working, each earning lower wages. More parents will retire later, more kids will move in with their parents, more small income streams - so that three "underemployed incomes" come to more than one "fully employed income."
QE creates inflation. Inflation increases asset prices. Foreigners would be wise to buy US assets while their dollars are still relatively strong, then profit from asset price increases when the dollar weakens. A dollar today could buy what $10 does next year. Regardless of currency, real assets like property and profitable companies have their own value. Now debt is a different matter. Anyone holding fixed-interest debt in this scenario will get wiped out. Ditto for anyone living on a fixed income. There are winners and losers in every scenario.
You wrote: "While many pundits have predicted that the final closing low in the bear market was reached on November 20th, we at Hurricane Capital Global Alpha Fund still believe there will be more red than green in the stock market in 2009."
And right you are until proven wrong.
Mark Perry - - -
Your numbers for "consumer debt" sound reasonable to me (I haven't checked them), but I believe the author was referring to "debt of consumers", which is a much larger number. I haven't checked the author's numbers either, but they seem quite reasonable because of the increase in mortgage and home equity debt. Comments by Doddsville investment and donzelion have also made this point.
User 305589 - - -
You are absolutely right - there are under-priced stocks. But the author is also correct - the average over all stocks (the S&P 500 given in reference) is over-valued based on the information now on the table and any number of reasonable forecasts for 2009.
Also, your comment about credit markets does not include consideration of credit worthiness. If business and personal prospects are diminished, credit will not flow as in the past (not even close to those levels) and the credit markets will remain "frozen", but not due to liquidity.
Economic activity is influenced by momentum and there is little debate about the direction of momentum right now. Huge ships underway take a long time to turn. It took 12-15 months to turn the ship from full steam to one compass point to the current course full steam to the 180 degree opposite compass point. There is no sign yet (at least to me) that there is any slowing of the new course momentum. Once there are some signs (slowing the new momentum) we can start looking for bottoms.
In the meantime, buy the few under valued stocks you find. But be sure to monitor them for any contagion from the rest of the economy affecting them.
"The study, "Lights Out In 2009?" warns that the U.S. "faces potentially crippling electricity brownouts and blackouts beginning in the summer of 2009, which may cost tens of billions of dollars and threaten lives." ..."
www.utilityproducts.co...
Twain apparently also wrote.
"Do not fear the enemy, for your enemy can only take your life. It is far better that you fear the media, for they will steal your HONOR. That awful power, the public opinion of a nation, is created in America by a horde of ignorant, self-complacent simpletons who failed at ditching and shoemaking and fetched up in journalism on their way to the poorhouse."