US Economy Still Has a Ways to Go

I would not say that the state of the US economy is in jeopardy, but it does look to have some problems. What many thought would already be over seems to be stringing out over a much longer period of time. Many on Wall Street have said that the third quarter of this year would see the stock market edge higher with a stellar fourth quarter.

These estimates have changed as it looks like the US economy is stuck between a rock and a hard place. The hard place seems to be the current housing market and financials that are holding the equity behing it. The rock is inflation and oil as they seem to be running hand in hand. The beauty of the stock market is that we know from experience most bear runs are much shorter than bull runs, but they are also much faster moves.

A bull market is nurtured like a plant and slow steady growth is helped along by decreasing interest rates and growing money while trying to limit inflation as best we can. Bear markets are much quicker, because consumer sentiment is a very important factor which decides whether the consumer wants to spend his or her disposable income or save it for a rainy day. It behooves the Fed to make down markets end quickly although painfully so we can all remain happy in the long term and help keep the world's economy going.

The largest difficulty in this market is that the average family has the bulk of its retirement money in its home. It has always been a safe bet for the US consumer and should continue to be going forward. But that is why it is the greatest concern. If the housing market goes, so does the US economy.

Don't get me wrong, I am not one of those people screaming doom and gloom about the economy. I am just still bearish on the financials and housing market. I think we will see 10,000 before the market turns around, but by the time it gets close to this bottom it will be far oversold. I also believe we could see this before year end. This does not mean that agriculture and energy are not still attractive as those markets look good, along with companies with broad overseas exposure.

Inflation will continue to concern the Fed as it will not be able to cut rates. We have seen the financials lock up credit and make it more expensive to get loans, keeping the extra profits on refies to help with the major losses on subprime and Alt A loans.

The cuts in interest rates were hoped to save some people's homes and gave many the opportunity to refinance out of their variable interest loans and lock into rates they had the ability to pay. Now that these cuts are done, most of the refinancing is done, leaving others without the ability to pay.

There is a moral dilemma and that is the financials' responsibility in giving out variable loans when the new rates would go up or that people would not be able to pay. These problems were wide spread, but who is essentially at fault, the financials for doing it or the people who took the loans out of ignorance?

About three years ago, I took out a secondary loan to fix up my basement. In doing so, my wife set up everything and wanted me to go by and sign. I didn't think much of it as she was working with a loan agent that had been a friend of hers for twenty-three years. I sat down to sign the papers and luckily I decided to read them. For some reason I had time on my hands that day.

After looking over the papers, I saw the loan had a variable interest rate. I was planning to pay the loan off in the next six to twelve months and interest rates were already about as low as I thought they would go. I looked at the gentleman who had handed me the pen, and said why would I want a variable interest loan, and he told me it was the cheapest way to go right now. For your average person that would be good enough, right?

I don't know much about economics, but I knew at that point interest rates had a greater chance of going up than down and was a little mad, not so much about the money, but that he thought I was a fool, and definitely not a Motley Fool. If a friend of that long would do it, just to make a buck, then what about the Average Joe?

I do believe we are far from the end of the write downs, and I do believe it will be much more painful for the financials as we could see many of them sell off another fifty percent or more in the upcoming months. The Fed and Congress will need to figure out how to expedite these write downs and get the economy going. The slow reduction in value of the financial and the losses being passed down to their investors will need to be quick and painful, just as Bear Stearns found out in order to find a bottom.

Let the bottom fishers feel the pain while you stay in overseas funds and other companies still in a bull market, limiting downside and waiting for things to take off again. Even companies like Citigroup (C) and Goldman Sachs (GS) will still feel the pain of others around them, because investors will believe that they still have or will begin to write down losses.

Currently, I have holdings in Transocean (RIG), Chesapeake Energy (CHK), Potash (POT), Monsanto (MON), and Intrepid Potash (IPI). The reasons for these stocks are that agriculture looks to have momentum from a multi-year prospective. Oil services are insulated somewhat from the carnage, even if oil does experience a wild sell off as they have not seen the exponential growth of the commodity.

Finally, natural gas is a play on next year and the chance that legislation in the United States will move towards increasing the grid through the use of green energy sources and the possibility that plug in hybrids used with gasoline and batteries will allow for these sources to help power cars to a large extent going forward.

All said, the market has a ways to go but I believe that most of the problems are over. Since interest rates will not be cut anytime soon, it will take time for the entire subprime meltdown to occur. I am not currently shorting anything in my account and most of my non-stock holdings are in overseas funds.

The one thing to remember with respect to financials and any stock that has been beaten down over the last year or so is that fundamentals look bad, so shorting seems to be a good move, but with market consolidation and volatility it could be dangerous for those who cannot afford to lose the money. Bear Stearns is a great example as it was sold off and then shot straight up after JPM decided to buy it. Play it safe or start putting down small positions, but wait until there is more transperancy.

Other companies such as General Motors (GM) and Ford (F) will continue to see huge losses. I think that consolidation is inevitable in the future and also believe that many of the emerging markets will begin to introduce vehicles to a larger extent in the upcoming years.

All of this seems very negative, but if it is timed right, the average investor could make a lot of money.

Comments

[Msccube:]

I think the US equity market is facing serious problem.

Let us compare the current situations with the Japanese situations happened 15 years ago. Japan was facing the burst of bubble economy. They had serious problem with the real estate sector and their banks were carrying huge bad loan.

Japan 15 years ago:

1. Japan was the second biggest economy in the world.
2. Japan was facing the collapse of housing market.
3. Japanese banks were carrying huge amount of bad loan, and the government tried to save the bank.
4. Japan had excellent industrial bases.
5. Japan has had huge amount of foreign reserves.
6. Japan was not facing high priced oil at that time.

Today's USA
1. USA is biggest economy in the world but has larger population than Japan.
2. USA is facing the collapse of housing market.
3. USA bank is carrying huge bad loans, and facing credit crisis. The same as Japan, the government wishes to save the banks.
4. USA has excellent industrial bases.
5. USA has huge amount of foreign debt, the largest in the world. Don't even think of any foreign reserves.
6. USA is facing high priced oil today!

I would say that it makes sense to short S&P 500 and S&P financial index. After 15 years, Japan is not completely recovering from their problems although things are going better.

2008 Jul 13 02:55 PM

[nova:]

" USA has excellent industrial bases". What are you smoking? Do you remember hyper huge trade deficit?

Clinton and GW Bush killed US industrial base. Just look at auto, high-tech, appliances, electronics, etc.,

Outside of defense, software and biotech, the USA has nothing. Even American agriculture is in trouble.

Oh yes, we have Hollywood. Sorry, they have nothing with an industrial base.

2008 Jul 13 04:27 PM

[Steevo:]

I think its a reasonable assessment Michael but I'm not sure you were negative enough. I think the consequences if Fannie and Freddie becoming insolvent pose the possibility of something akin to a 1930s scenario. If the government takes them over the government takes their debt which just about doubles our current national debt, just imagine the rise in taxes for starters. If the government doesn't take them over but gives 'support' for a while until they eventually fall, we will not only be in an official recession but very possible a depression.

Right now is a good time to take gold very serious.

2008 Jul 13 05:04 PM

[tommytwotimes:]

I agree with the above, but Freddie and Fannie will fall with or without help from the feds, right? I think they should let them fall too, but either way spells recession which we are already experiencing. I think a depression similar to the 30s needs to be defined by three words. Housing (homeless), jobs (jobless), and food (hunger). The housing issue is present and unemployment is growing. Threatening the food supply could be the perfect storm and there are issues becoming more volatile in that industry.

2008 Jul 14 12:40 AM

[Vox Rationalis:]

Nova wrote: "Clinton and GW Bush killed US industrial base. Just look at auto, high-tech, appliances, electronics, etc.,"

Take a few minutes to actually look into this. You'll find that you're wildly off-base. In fact, manufacturing output grew twice as fast during the 1992-2005 period as it did during the 1979-1992 period. Since 1992, motor vehicles and parts production has increased by two-thirds (roughly twice that of GDP growth), and computers and electronics manufacturing have increased something more than 1500%. As for appliances, well, I don't know. But why should they be assembled here instead of in Mexico?

At least, that's a quick and dirty early in the morning take on it.

2008 Jul 14 04:39 AM

[Vox Rationalis:]

Nova also wrote: "Even American agriculture is in trouble."

Wait a second, your whole post was in jest, right? You're not actually serious about this assertion, are you?

2008 Jul 14 04:40 AM

[john s. gordon:]

industrial base erosion in u.s.a began in 1981 with r.reagan's overvalued dollar. the u.s machine-tool industry went down the tubes (unable to compete in world markets) & has never recovered.
> jack

2008 Jul 14 08:31 AM

[Paul Killinger:]

You guys are now almost uniformly BEARISH about our economic prospects going forward. That means the market's turnaround cannot be far off. We'll see.

2008 Jul 14 09:57 AM

[Jason Rines...:]

That's a good point Paul, but there I think most of us are in 'wait and see' mode. Many fell for the bear rally these last three months thinking the worst was over. Accelerated job losses and lack of lending to NOBODY except for the bigs with substantial collateral told me this was a bear rally. Can't have 51% of our GDP (multinationals and government) barely feeling pain and 49% of Main St. bilked dry and still think our national economy will remain strong. History tells a lot. The real question and one the writer takes a stab at, is will we see depression conditions before it's all through? Times always get better, I predict a massive Bull market in 2020!!!

Now, what we appear to have is deflation/inflation. We are feeling stagflation at this stage of the pain but it appears things are getting worse. The writer and I feel the same way, there is ample opportunity to make money. Watch the politics of NYC and Washington.

They are coming to the conclusion JOBS must be created and we must increase our energy supply. How fast this occurs is anybody's guess because neither political candidate looks strong on the economy and nor do we know how taxes will change in the short or mid-term until after elections.

Overseas looks decent still as does alternative energy, consumer healthcare and tech still holding up and higher will be a big story next year, especially online. Gold should be decent short term and go up nicely in the mid-term. Oil? Yeah... no comment. Those going ultra long wager against the American consumer themself which has been discounted already as fodder. Yes to some extent but Main St. votes and the ire from the constituents cannot nor should no be ignored.

2008 Jul 14 10:46 AM

[Jason Rines...:]

(higher=higher ed)

2008 Jul 14 10:47 AM

[cyerman:]

You (MF) say, "I would not say that the state of the US economy is in jeopardy, but it does look to have some problems." Just what circumstances would you list that would indicate that the US economy is in jeapordy (when and if)?

2008 Jul 14 02:58 PM

[Marcus Aure...:]

I wonder what the thought is about the state of long term rates 10 years out from now is? 30 year mortgages in my locale are currently varying from about 6.25% to 6.75%. A local bank is offering a 10 year arm for about 5.7%.

This will give us the chance to gobble up a lot of principal and keep an eye for long term rates in the same neighborhood (about the start of this year late last year 30 year mortgages were going for 6% +/- .125%).

However, if we don't figure out our energy situation I fear interest rates on mortgages may be going back to the way they were in the late 1970s.

2008 Jul 14 03:43 PM

[legmaker:]

When speaking of the US economy and its being in jeopardy, my main worry is the US dollar. I think if there is a catastrophy of some sort that would cause oil to rip higher(war with Iran) and oil were to go up to $250 a barrel there would be serious problems. If using core inflation is the correct way (I have to trust the likes of Greenspan and Bernanke) then inflation is still in check and we can slowly let the housing bubble run its course. I still believe that the world relies on the United States and if we were to not just have a bear market and a "depression" as I would call it, the whole world will feel it. That is the one thing protecting our living on credit while the world saves.

2008 Jul 14 10:23 PM

[morgan77:]

Looks like MON is making a bounce-
I'm happy to see a few different (and diverse sectors) prepared to go up right now (housing, agr., materials)
interesting piece about the future here: www.greenfaucet.com/tr...

2008 Jul 22 06:17 PM