Seeking Alpha
Recommended for you:
Profile| Send Message|
( followers)  
Back in late August I did a series of predictions (a roadmap if you will) in my post 'Et tu, September?' Most were quite negative, and unfortunately most are coming to fruition... One thing I like about the blog is I can have a history of thoughts, sort of an open journal, and go back to see why I thought things at the time, and to revisit those themes to see what led me to those conclusions. Back when I wrote the late August post, the politicos were mostly dismissing the issue of a housing crunch but finally relented with a breathless speech by President Bush on a plan to help out a whopping 100K home owners. We had just had our 'surprise' 50 basis point Fed/discount cut and people were cheery as the Fed was going to fix everything.Now a quarter later it's time to update the thoughts and thesis for the coming 1-6 months. We now have the next bailout...err, solution by the politicos. Now its up to "2 million" home owners, with proposals to freeze their rates. And people are cheer that the Fed is going to fix everything. The more things change....Keep in mind, these are not 'stock market' predictions, more of 'economic thoughts' - how the market 'behaves' to these is anyone's guess. Remember, sometimes bad news for the real people of the country is good news for the market - until the bad news becomes so overwhelming, it finally turns inward on itself.The Consumer/Housing/Inflation
  1. First and foremost I think this focus on subprime is misguided. The subprime borrower is a relatively small piece of the puzzle and truth be told as a heartless capitalist, I think many of those who bought homes in the subprime category should never of gotten homes. Many would not have gotten the under 6% fixed rate mortgages with income documentation. So while it is correct to say this is a smaller slice of the mortgage market and ask why should they effect the economy as a whole, my argument is their troubles are not the central issue facing us. It is "everyone else" (excluding the top 5%)
  2. I keep hearing how housing is 4.5% of the economy.... baloney. There are so many related jobs to housing that this figure is laughable. Estimates I've read are 1 in 5 jobs in California are related to housing in one fashion or another. And California is a huge part of the US economy. This is also why I find laughable when I read the housing issue is contained to California, Florida, Michigan, Ohio. Well even if you believe that line of hooey, those are 4 of our top 10 biggest states by population. California alone as a stand alone country I believe would be 7th largest in the world (by GDP). We are a service economy - yes we have some exports still but nothing like 20 years, 30 years, or 40 years ago. When a huge part of our service economy implodes, that effects far more than 4.5%.
  3. Going back to point one, I think the consumer (not subprime) is in trouble. Many people bought over their heads in the past 5 years (housing) all across many income strata. To pay for the consumption, they drew down equity from of their house. And now the homes are not rising in value and are in fact falling in most cases. This is where my main fears lie, not with the subprime. These are the people who have driven the economy over the years - the 'middle class' and 'lower upper income' class. I've read countless times (who knows the exact number) that 70% of people live paycheck to paycheck, regardless of income. To cover their shortfalls, they'd dip into the house equity (those who owned homes). Now that spigot is turned off and not coming back anytime soon. Now what?
  4. Now what indeed - you live paycheck to paycheck, you have very little buffer and savings so either you draw down consumption or you head towards bankruptcy. This is where our real troubles lie in my opinion. In the past half decade especially, anytime there was trouble there was always a second mortgage, a HELOC, etc. Now those are gone. And even when the mortgage market comes back, without rising home prices you don't have equity to draw on.
  5. Wages are rising on average 3-3.5% a year. Inflation? Far higher. The consumer, living paycheck to paycheck, with little buffer in their budget, fought this by drawing down on their credit cards and house. That game is getting long in the tooth. Inflation? Rising far higher than government tells you, and far higher than 3-3.5%. Many would cite 8-11% as real inflation. Health care, energy, tuition, and now food - you name it.
  6. Food inflation is going to be the next killer - it has started the past year, and it will continue; food inflation is due to factors outside our general control - in part to worldwide demographics (in emerging markets, middle class moving from a rural to an urban lifestyle), food habits changing worldwide (a push to more western diets heavy on meats) and a misguided push to ethanol (diverting corn from food chain to energy chain). In short, a world of shortages. And this does not change if China and India drop from 11% GDP growth to 3%. These factors are here, and staying. Yes, food will ebb and flow - it cannot continue at the pace of 'inflation' it is going now - but it has already started to create demand destruction and for the countless people living paycheck to paycheck, they don't have the wiggle room to add $40 a week to their weekly grocery bill. We are going to a world of shortages (with ebbs and flows over time) and the world is not set up for 4-5 billion urbanized.
  7. Jobs will remain the main wildcard - we are already seeing the losses in mortgages, housing, and "some" financial - to what level this spreads through the rest of the economy as the economy slows will be a key driver in how bad this slowdown gets. If job losses are contained, it could be relatively shallow of a drop; if corporations really start cutting due to profit margin erosion it could be ugly.
  8. Returning full circle to homes - prices are too high. The average American cannot buy a home in many parts of the country (major urban areas) at 6% fixed rates. Prices detached from rents and wages due to the 'innovative' financial products cheered by Uncle Alan. If those innovative products had not been produced, asset prices (home prices) would never of risen like they did... now that we are in a 'unrealistic' home price environment relative to wages, those prices need to come down and in many cases severely adjust back to reality. When this happens we will be near the bottom. We are not close.
Corporate America and the Markets
  1. Next shoes to drop? Corporate profit margins. I found this yesterday on Realmoney.com and have been saying this would happen for months "Three months ago, Wall Street forecast Q4 operating earnings growth for the S&P 500 of 8.8%. Today that number is down to 1.1%. " I still believe 2008 profits are far too high in most industries. And as they get cut, in theory stock prices which are in essence a reflection of profits, should be cut. Look for a slew of warnings on 2008 profits come January... (I am still incredibly curious on how a cut back in ad spending will affect Google)
  2. Energy prices will pressure many industries and those industries dealing with food are already seeing massive pressure on profits. While consumer related stocks have already taken a hit and are starting to price in recession - corporate related stocks have thus far held up relatively well - I believe this changes in the next 2 earnings seasons (January and April)
  3. The transportation companies are already telling us we are heading to recession. YRC Worldwide CEO was saying it 3 months ago, now Fedex CEO is saying a "slowdown, but not precipitous decline".
  4. Auto sales will see a horrid 2008 for all the same reasons mentioned above - negative wealth effect, lack of confidence, inability to finance via home, wage stagnation in the face of real inflation.
  5. Commercial real estate will start to drop. Thus far it has held up, but in a slowing economy why would rental rates hold up? They won't. It won't be as bad as residential real estate, but it will be far worse than it is today.
  6. Housing companies will begin to go bust. I don't know if it will be in the next 6 months, because they are beginning to take desperate steps (note Lennar's sale of their land stock at 60% off to Morgan Stanley), but it will come to the weaker players sooner rather than later. To keep the boat floating, new home prices will be slashed - this has now begun, it will continue and accelerate - while stubborn home owners cling to the hope of inflated 2005 prices - the reality will be shown to them when brand new homes are built at 40% off the value of what hey paid for 2-3 years earlier. This is when the correction 'really begins'.
  7. Credit card debt, much like residential mortgage debt, is now being packaged into "ultra safe" instruments and sold on Wall Street as a way to squeeze out more yield. Don't these cats ever learn? I don't know if it will be in 6 months, but in 2009 you should start hearing how these turned out to be pretty bad bets as the strapped consumer is turning to credit cards as a lifeboat now that the house ATM spigot is turned off. This will be a longer term play but truly the 'financial innovation' in this country never ceases to amaze.
  8. The web that is credit will pop up in places we don't even know about yet - you are starting to see it in state governments in Florida (and Montana) You will see it in other places - credit is the lifeblood of the service economy, and these 'innovative' schemes, err I mean solutions will show themselves in many places we'd never expect. If we start seeing money market mutual funds needing to infuse cash to keep the $1 NAV, that will be an interesting time indeed....
  9. Credit is drying up worldwide - until banks are honest about their exposure this will continue to be the case. "Solutions" such as the Superfund, which simply moves hidden assets from 1 pocket to another only draw out the issue. Banks know best what dirty deeds they have done. And they know if they did it, a lot of other people did it. That's why they don't trust each other - LIBOR rates remain extremely high (a measure of rates banks use to lend to each other). The US banking system is a big black box of 'innovation' - until a lot more of the onion is pulled back and revealed we won't see the stink.
  10. Corporations will become very conservative with cash, beginning to hoard it (less buybacks for example) just like the banks are doing now. This is never good - not for a financed based economy. Risk taking will be looked down upon.
  11. The world will slow down - I don't buy this decoupling one bit. Yes, foreign countries are better equipped to handle slowdowns, but not immune. Their middle class is growing but has nowhere the consumption levels of the U.S. or Western U.S. They will get hit, but its all a matter of 'relative'. They will still do 'relatively' well, but right now many markets are priced for perfection.
  12. At this point other central banks are holding rates steady or in fact raising rates (i.e. Australia) to fight inflation. I think this changes once the reality of the U.S. situation happens. After all we are all tied together, and a recessionary USA is not good for anyone. I think central banks in developed world by next year will begin cutting rates in unison as (a) Western Europe enters its own slowdown and (b) they are forced to, to bail out the USA for its mistakes. Inflation will have to be worried about another day. We will be going back to a world of easy money, so we can repeat this whole cycle once more (how sad).
  13. China - everyone says its safe to buy until Olympics 2008 - this tells me that is not going to happen. When everyone thinks something, it never happens. Either the bull will happen far after the Olympics or the bust will come sooner. I vote sooner. Again I am not speaking of the economy, but the market. The economy is overheated in China and they need to take steps to slow it down to a more sustainable 7-8% type of growth. How that plays out is anyone's guess, but inflation is a real worry there (food especially).
  14. Ironically so many US investors are now piling into foreign markets as safe havens - as always, those piling in last will get the hammer applied to them. While foreign markets (emerging) will be the place to be the coming decades, there will be ebbs and flows, and the coming 6-12 months could be an ebb. And ebbs in those markets don't mean 5% corrections in their markets. Again, not a market fall but a "fear of global slowdown" could severely hurt these markets - even if there is little truth to a major slowdown in those specific markets (i.e. most countries would love to "slow down" to 6% GDP growth)
The Response
  1. I expect a lot more programs to "save" the banks, save the poor homeowners, save everyone. More government programs, more bailouts, more money printed out the wazoo at the Federal Reserve, perhaps a surprise cut here or there, perhaps a major discount rate cut. I've said at 2:31 PM Halloween when the Fed signaled they would go back to neutral, forget about it. We are going to mid 3%s by spring 2008 on the Fed funds - the more I see, the more I could be conservative. Maybe low 3%s or 3% by summer 2008. Anything and everything will be on the table to bail out the economy into an election year. That's just the reality folks. The long term be damned, whatever course of action is needed to be taken will be taken. Hence, that's why its always dangerous to be too short the market - many forces will conspire to make sure serious damage is limited. Massive amounts of liquidity will be fed into the market. (and dollar will continue its death spiral, eventually bottoming but not "bouncing back" anytime soon)
  2. Foreign buyers will be flooding the US market by spring summer 2008- specifically sovereign foreign funds - it has already begun. But this is just the first steps - many US assets will be taken over. This time it is "for real", unlike the fears of Japan taking over in late 80s - petro dollars and massive trade imbalances make for very rich counter parties. In fact this is going to be an issue for many years as we have taken no steps to shore up our systematic issues of unfunded long term liabilities, trade imbalances, and petrol dependence.
  3. Politicians will be talking in very protectionist terms, and as the economy worsens, it will only get worse. I believe food inflation will be a major talking point in fact. Whom they will blame (considering the farming lobby is a major contributor to political coffers) will be interesting. The economy will become the #1 issue heading into the 2008 presidential race. President Paul will realize this.... oops, that's not reality. President Huckabee? Honestly I believe this man's populist talk of a 'fair tax' will gain a lot of ground into the type of economy we will be facing by spring 2008. So we could get an 'upset' results by a dark horse. In fact if the election were fall 2009 instead of fall 2008 I'd almost guarantee it, but by spring 2008 many of our economic problems will not have fully taken effect.
  4. Whatever solutions the politicians do, unfortunately will be focused on the near term - and be as always reactive instead of looking at the root cause and getting to the heart of the problem. If it's a matter of lack of will, lack of education, lack of vision - I don't know. I just see nothing being done for the long run. As with almost everything in this country on the political front, we will act in a reactionary measure after its created massive problems for us (social security is a small bone compared to Medicaid and we can't even address social security as a country) - so look for draconian measure perhaps in 15 years since we refuse to address it now. The 'solutions' will be mocked in this blog I am sure.

So there you have it folks - on the surface it sure sounds gloomy. Whatever numbers the government puts out, and if they indeed eventually call it a recession or not, well that is subjective. I do see a very serious retrenchment as global forces are now at the point that they overwhelm "some" of what the Fed can do. In the long long run, a world of shortages is going to create a very interesting time. I do believe in the "long run" technological innovation will solve many of these shortages - but the question is what happens between "now" and the "long run". And for all the doom and gloom above, I do trust principles will be tossed out the door and the government will do everything in its power to stimulate, stimulate, stimulate - by any means possible. So as investors we can cheer that; as Americans and those living supposedly in a free market? I wouldn't say the same.

Source: Shortages, Inflation and Withering Credit: What's in Store for the First Half of 2008