The Ultimate Game Changer: Why 2009 Will Be Worse Than 2008 (Part 2)

I don’t want to belabor the point but wanted to stress the fact that credit, saving spending and investment will be changed for a generation. People will be forced to save more to buy stuff they could previously buy with little or no money down and low interest. Frugality will be a way of life, not just in the consumer sector, but also in the business and government sector. And the government (federal that is) can not create enough jobs to mitigate the economic pain in any meaningful way because the private sector is likely to cut another 6 million jobs this year and state and local governments will cut more than the federal level is apt to create.

I can’t see how and when consumers and businesses will be willing AND ABLE to spend more. Generation X & Y have pulled forward a lifetime of sales. Many hundreds of billions of dollars worth of stuff bought on credit in the last few years would have been bought in the period ahead if folks had to save for it. Instead, consumers and businesses alike have to retrench in order to pay overwhelming debt service burdens. And one man’s spending is another man’s revenue; and so it goes, the multiplier effect in reverse.

These dynamics don’t change overnight. And to the extent that you buy into the bull crap (pun intended) spoon fed to you by CNBC pundits employed by fees on your assets your net worth and quality of life will suffer for it. Understand that the Abby Joseph Cohens of the world will never implore you to take your money out of the Goldman Sachs (GS) of the world because it means they get paid less or fired altogether. It’s not good business as they say; but if you ask me its bad business.

Strategists putting a 1100 and 1200 targets on the S&P500 (SPX) as 2009 started were flat out irresponsible at minimum and probably disingenuous as well. I say that because not only are they clueless about what the earnings on the S&P500 might have been if the constituents remained the same; but many names are being changed to protect the guilty as they say, so what does it mean to the market that the new constituents earn whatever. If I recall correctly, they mentioned $53-$55 in EPS this year (which interestingly was at the low end of the street) and $60 next, but many of the top market caps have been replaced with companies with better balance sheets and earnings. Who in their right mind would take a skewed sample and put a high teen multiple on it and say that’s what they honestly expect. I’ll tell you who – its people with a vested interest in you not allocating capital away from equities. But that’s exactly what you ought to do.

Another reason why I doubt equities can snap back a lot anytime soon is because I can’t recall a time when equities have gotten pummeled to the extent they have and other assets are as attractive as they are. Investors that lost 50-60% in what was supposed to nimble “HEDGE” Funds (which didn’t hedge well) are going to be done with them in many cases and shift money back into the mutual funds (which have much less leverage) which never lost that kind of money for them. They will also buy debt securities, corporate bonds, munis, converts and real estate among other things. Sure there’s a lot of money that will come out of treasuries but it's not going into equities to the extent that it has historically. And that money on the sidelines is not all going back into the market either. Much of it will go to redemptions and other asset classes – I doubt many will underweight cash as much as they had in the past, regardless of what yields are.

As the market rallied a couple of weeks ago, I was shocked to see how many were sucked into the idea that the worst was over. Well educated money managers bought into the company line.

Many remain in a state of disbelief and think it can’t get much worse now. They think “I can’t sell now, it’s too late”. Wrong again, uncertainty has never been greater, our financial system is melting down and the meltdown is creating massive collateral damage. Otherwise good companies are seeing credit issues impair their operations; which are already under duress on the demand side. As corporate profits slide and the outlook for growth deteriorates so too will equity valuations. Earnings and Multiples will remain under pressure and equities will decline – if you don’t reallocate out of a long only overweight equities portfolio, the market will do it for you.

So the decline is apt to be more protracted than most think and the downside will be such that the comps can’t be easy enough. Retailers are a good example of this – things got bad with retailers almost 2 years ago, they’ve been up against what should have been easy comps but still comping the high teens NEGATIVE for many. Sure, we may be approaching a point where it's hard to get MUCH worse (much being the key) but I think the disconnect here is that everyone is assuming that things bounce back as they did in past cycles when consumer balance sheets weren’t decimated and banks were healthy and lending.

Generation X & Y have pulled forward a lifetime of sales (which would have gone to sales in the period ahead and would have been more money with interest instead of deficits and unmanageable debt service burdens. One consumer’s/business’ spending is another consumer’s/business’ revenue and the multiplier effect you heard about in econ 101 (when the butcher buys baked goods and the baker then buy candles etc.) works in reverse. That’s how a mild recession turns into a really bad one – the butcher and the baker cut back the spending and employment and the candlestick maker goes out of business.

My point in all of this is not to be doom and gloom for doom and gloom sake – I’m not trying to be Marc Faber or Jim Rogers talking my book on Bloomberg or CNBC. I’m saying all this to impress upon you how important it is to worry more about containing the risk in your portfolio than missing out on a rally that has a very low chance of happening in the first place.

That Goldman Sach’s S&P500 target is now almost 45% away and the hurt is palpable. It’s not too late to reduce exposure to equities and increase exposure to cash, and high quality/much less risky debt. That doesn’t mean you shouldn’t hold equities at all, it means to hold less. Avoid the temptation to bottom-fish banks, brokers, cyclicals, industrials, transports, materials, techs and other relatively high beta, economically sensitive sectors and instead focus on well managed, well financed less cyclical names likely to survive this hell of a cycle. I think names like DE and NUE are still good shorts. And am likely to put FSLR on short as well. I’ll be back to you soon with more names both short and long. But first I’ll tell you why I think TARP is a joke and I’ll suggest what I think is a much better way to stabilize the financial system in a much more cost effective way.

Disclosure: short DE and NUE.

Comments

[Maya_:]

I think you will get burned by shorts on a 1 week and 1 year outlook; but may be on to a winner on a 3 month outlook.

Jan 21 12:11 PM

[Fred Voetsch:]

No, no, no...there's way too much common sense here. What we need is HOPE: BUY, BUY, BUY!!!!

:-)

--Fred

Jan 21 02:21 PM

[sr9web:]

"Another reason why I doubt equities can snap back a lot anytime soon is because I can’t recall a time when equities have gotten pummeled to the extent they have and other assets are as attractive as they are. Investors that lost 50-60% in what was supposed to nimble “HEDGE” Funds (which didn’t hedge well) are going to be done with them in many cases and shift money back into the mutual funds (which have much less leverage) which never lost that kind of money for them."

Think this through - you are contradicting yourself.

Jan 21 08:50 PM

[Allen Phatimer:]

Not contradictory at all and I didn't think I needed to think twice about it when I wrote it; but I could be wrong. The idea is that hedge funds are much more levered than many mutual funds aren't. There aren't many mutual funds that partake in the 130/30 or 150/50 strategy so if assets are shifted to mutual funds from hedge funds then there will be that much less demand for equities, ergo, less money in the game to support equities. Thanks for reading and commenting. If I'm missing something, feel free to let me know. thanks


On Jan 21 08:50 PM sr9web wrote:

> "Another reason why I doubt equities can snap back a lot anytime
> soon is because I can’t recall a time when equities have gotten pummeled
> to the extent they have and other assets are as attractive as they
> are. Investors that lost 50-60% in what was supposed to nimble “HEDGE”
> Funds (which didn’t hedge well) are going to be done with them in
> many cases and shift money back into the mutual funds (which have
> much less leverage) which never lost that kind of money for them."

>
>
> Think this through - you are contradicting yourself.

Jan 21 11:19 PM

[2houndz:]

I agree that your logic is correct as it relates to the private sector, but if you think our government will adopt a philosophy of frugality then you are dreaming.

Jan 22 09:11 AM

[Guero:]

I think you have it just about nailed sir. The psychological impact of this "panic" will be far-reaching for younger generations. They now know that economic destruction is real and is not just something you read about in a history textbook. My teenagers are looking at all this & freaking out. I just remind them that this is a huge lesson in progress, and if they learn it well they will be fine.

Jan 22 10:19 AM

[misiosnechacz:]

Very bearish but true
You are right about peole not coming back with their money to the hedge funds. It's realy not enough to say it's going to better. We need some positive data to support this and push the market high. It's cheating yourself like it's winter and you know it but you are going out dresed like it would be summer and I can tell You one thing You will be back soon. The same happened to the january rally bad data killed most of the bulls.
1)My advice is to invest in gold and oil.
2)Wait for another rally and then short
3)One year perspective i think investment in EURO will give a good return
4)Other curencies that lost against dollar will bounce back it's just a matter of time have a look at Eastern Europe countries

sorry for my english

Jan 22 05:21 PM

[Allen Phatimer:]

So you suggest I'm making much ado about nothing. You're entitled to your opinion and I respect your view but I think (and time will tell who's correct about this) that your sentiment reflects much of what I hear and see both in the financial press as well as the traders and investors I know. I think I have a pretty good reference point as I speak to professional (present and former buy and sell side analysts and PMs), as well as many non professional investors regularly. The inspiration for what I wrote was precisely the widespread complacency I witnessed a few weeks ago and obviously still do. Too many people have and continue to believe that 'the market' always comes back stronger and its too late to reduce market exposure so might as well stay the course. I think most don't fully appreciate the magnitude of economic pain that is to come this year when employment, consumption, output and corporate profits decline throughout 2009 and into 2010 and the adjustments take much longer than those who share your view think. Our economy has changed in big ways. If you don't appreciate that now I think you will soon see that structural changes have altered income, credit, consumption, saving, investment and risk taking dramatically - all of which is very likely to lead to much lower output which coupled with personal and business balance sheet constraints, will require lower per capita consumption and investment. This has huge economic implications and is the reason that I and a good number of serious economists (and I'm not suggesting I am one) feel scared like never before. So the inventories going to zero non-real world theory is going to cost you (if you're poo pooing the idea of more risk aversion being the prudent course here) for concluding that the worst is over as far as supply demand equilibrium is concerned in any market (including labor and manufacturing). Inventory to sales ratios have declined almost continuously for a couple of decades now, yet that hasn't prevented minor cyclical swings from creating enduring excess capacity. Now you have the mother of all cyclical economic downswings, and I'm suggesting that its a secular thing which will last longer and be more painful than most think. Home builders, auto makers, retailers and almost all things high tech, though keenly aware of sharp sales slowdowns, cant reduce inventories fast enough. Inventories will adjust as production decreases, but that will take time still. And I think that you will thus see excess capacity in almost everything, including labor, for a long time. With that pricing power will be almost non-existent. Businesses will sell less at lower pricing and will have a very hard time dealing with negative operating leverage. If I'm correct about that, then corporate profits will remain under pressure longer and equity multiples will compress further. Sure you'll find good values, but they be scarcer than you think and many apparent values will turn into traps quickly. So my message is better re-consider how aggressive or defensive you should be; but to each his own, good luck. Thanks for reading and commenting on my article; appreciate that.


On Jan 23 10:47 AM Steve Pluvia wrote:

> Allen, history is littered with forecasts such as yours; the take
> home is this: you're better off trading what the market gives you
> rather than trying to guess what will happen. The most accurate
> sentence you made:
>
> "I can’t recall a time when equities have gotten pummeled to the
> extent they have and other assets are as attractive as they are..."
>
>
> There has never been a comparable set of events, obviously you could
> not recall such a time. The first big point you miss is this: economic
> downturns produce zero inventories. As Stim packages kick in demand
> will outstrip supply and we're back to the races. The second big
> point you miss is we are in a new market era. There has never been
> a world economic recession/recovery during our current era of lightning
> speed internet information. In this new era buyers from the world
> enter and exit markets in a manner never before possible. Stock
> market booms produce wealth faster than any other event. Worldwide
> market access = more market buyers = greater demand = 1999 on steroids.
>
>
> This is not your father's economy or stock market.
>

Jan 24 01:02 PM

[donzelion:]

"Strategists putting a 1100 and 1200 targets on the S&P500 (SPX) as 2009 started were flat out irresponsible at minimum and probably disingenuous as well..."

My suggestion: you wouldn't buy a stock without knowing the price at any given point. Same way, you shouldn't buy a strategist/analyst/spe... without knowing their "price" at any given point - what is their net worth, what are all their holdings, what are all their revenue streams.

Anyone who earns fees from any media that earns fees from advertising which earns fees from companies being covered is too biased to be trustworthy: and hence, everyone on television advising about stocks is unreliable by nature.

Jan 25 02:55 AM

[ATWshop:]

There is one simple line of advice that will keep investors out of the fire.

*** Trade what is happening...Not what you "think" is going to happen ***

This is NOT a time for Buy & Hold investing!!! This is a time for TRADING - buy on the dips and sell on the run ups! The days of Mutual Funds is fast coming to an end. They just do not have the flexibility to react to this type of market.

If you develop a "Trading" type of investing...it doesn't matter which way the market goes. It only matters that there is movement and you, as the Investor are able to take advantage of those moves. Will you get 100% correct = No. But taking a "Passive" approach is a poor investment choice! Learn how to use Stops and Trailing Stops to your advantage.

We need more articles about Proper Trading Techniques to help educate the general investing public... no author can call the market with any amount of accuracy... Just my 2c worth.

Jan 25 06:52 AM

[Daniel Moser:]

Buy and hold is not dead. Buy and hold has apparently been mis-interpreted by just about everyone out there claiming it is dead. No one suggests buying today and literally holding it forever. That is a naive assumption that today's price is the best price that you will see long into the future. Trading as described by ATWshop is really a wreckless recommendation for the average investor i.e. the people who work for a living and allocate some portfion of their savings to equities. Furthermore the average investor does not have the education nor will to do the homework necessary to construct a properly designed trading system and modify that system when it ultimately breaksdown (and they all do). Mutual funds will never be dead. So long as people need assistence in allocating their savings between different assets. Sure passive investments with monthly or annual reinvestments will never put you on the Forbes top investor list nor Trader Daily's big income award...but it will very likely provide a decent source of return that is suitable for the average person. Quite frankly if ATW recognizes that no author can call the market with any sort of accuracy....why then would he/she think it a prudent decision to build trading systems or use technical analysis which by their very nature attempt to "call the market" all the time?

Jan 26 04:40 PM

[Allen Phatimer:]

For what its worth - its not as simple as it appears you think. Of course buy and hold looks like a losing strategy in a bear market but that same bear market will set up many phenomenal buy and hold opportunities. Even Warren (my investment horizon is forever) Buffet sells stocks on occasion. There are a great many ways to skin a cat in this business - some trade, some invest, some do both. I try to do both as well as I can because I think it makes sense to use solid trading cues to optimize entries as well as minimize risk. Whatever you decide to do as you are learning, do it with minimal money because mistakes cost real money and I can assure you that you are much more likely to make mistakes than you are to get lucky. Create a trading plan, then paper trade and analyze your results for a couple of years before you go all in. Try to minimize mistakes. This is not an easy game even for experienced pros. I like to try to catch big moves in names I know well. I do the fundamental work of understanding a business and the industry it operates in and then wait for an opportunity in valuation and/or emerging technical improvement. It takes a lot of study and diligent analysis as well as historical references. It takes many years before you really see charts and financials the way they are meant to be seen. In the meantime you'll be winning and losing the wrong way as they say. You're thus likely to develop bad habits and biases which will cost you money. There are a great many nuances that make conventional wisdom a tricky guide and a great many rules of thumb that kill. Try to learn as much as you can before you decide on a holy grail. Read the articles I wrote on individual stocks.


On Jan 25 06:52 AM ATWshop wrote:

> There is one simple line of advice that will keep investors out of
> the fire.
>
> *** Trade what is happening...Not what you "think" is going to happen
> ***
>
> This is NOT a time for Buy & Hold investing!!! This is a time
> for TRADING - buy on the dips and sell on the run ups! The days
> of Mutual Funds is fast coming to an end. They just do not have the
> flexibility to react to this type of market.
>
> If you develop a "Trading" type of investing...it doesn't matter
> which way the market goes. It only matters that there is movement
> and you, as the Investor are able to take advantage of those moves.
> Will you get 100% correct = No. But taking a "Passive" approach is
> a poor investment choice! Learn how to use Stops and Trailing Stops
> to your advantage.
>
> We need more articles about Proper Trading Techniques to help educate
> the general investing public... no author can call the market with
> any amount of accuracy... Just my 2c worth.
>

Jan 26 10:03 PM