Economic Outlook for 2009
By Akber Zaidi
Yorba Linda, CA
This past year has been historic in nature, with upheavals in virtually all financial and commodity markets. The indices were down about 40% across the board, their deepest losses since the 1930’s while commodities imploded in the second half of the year. The worst year since the Great Depression wiped out $17 trillion in global stock market wealth.
The face and structure of US markets changed forever in 2008. Hedge funds had dominated financial markets for years, but that will no longer continue to be the case. They found out that leveraging their balance sheets 7 or 8 times to lever small gains into large ones is not a business, it is more like undisciplined gambling.
The massive deleveraging last October practically destroyed the hedge fund industry. In December the discovery that one of its allegedly great investors, Bernie Madoff, was nothing but a fraud, has dealt the industry a death blow. We believe that hedge funds will continue to fall by the wayside this year and drag stock prices down with them. We would use strength in the market in the weeks ahead to sell stocks.
Home prices continued to fall for all of 2008. The 20-city S&P Case-Shiller index fell 18%, year over year, the largest drop on record. The index has now posted losses for a staggering 27 months in a row. One of the problems facing real estate is that the majority of sales consist of distressed properties such as foreclosed homes and short sales. Another hurdle is that banks refuse to lend. These problems will delay any recovery in housing.
Our research indicates that real estate will not bottom until mid 2009 at the earliest and could drop another 15 to 20% from current levels just to get down to historical inflation-adjusted levels. We recommend investors sit tight and wait for opportunities at significant discounts.
The nation's unemployment rate now stands at 7.2 percent, the highest level in 16 years. For all of 2008, the economy lost a net total of 2.6 million jobs, the most since 1945. Some economists think the unemployment rate could hit 9 or 10 percent by the end of the year. This rise in unemployment has been accompanied by a rise in savings. The savings rate since 1990 had been going down every year and bottomed out in 2006 at close to zero. However, this trend reversed in the second quarter of 2008 and the savings rate is now at 2.8%. When consumers increase savings, they spend less. According to Spending Pulse, total retail sales were down between 5% and 8% this holiday season. With continued higher unemployment, higher saving, and lower spending we believe this recession, which just entered its second year and is already the longest in a quarter-century, is likely to stretch well into this year.
The stock market typically bottoms 6 months before the end of the recession. If the recession ends in the latter half of the year, we expect an intermediate term bottom in the market in the spring or summer. One way to measure how far the market can fall is the price to dividend ratio. Until the 1990’s, the price to dividend ratio for the S&P 500 tended to center around 20. The current price to dividend ratio is 35. This suggests that a forty percent drop from the current stock market price is possible. We believe the bear market in stocks is not yet over and investors should safeguard their investments in this deflationary environment.
We have been suffering from deflation with the price of everything falling even though the government is printing trillions of dollars. The reason is the banks are not lending the money. Non-borrowed reserves sitting on the Federal Reserve’s balance sheet have jumped from under $2 billion in August of 2008 to over $774 billion as of December 27, 2008. All this high-powered money that’s piling up has the potential to be loaned out over 10 times its nominal amount, and eventually it will. When banks start lending we will have a prolonged period of inflation and economic turmoil. The only way out of this dilemma is if the US government decides that savings and production will stem this tide, not more spending and debt. Against this backdrop of higher future inflation, the fundamentals for hard assets including gold and commodities are very bullish. We suggest buying gold and other hard assets at their recent lows as a future hedge on inflation.
The “Panic of 2008” will be remembered as one of the worst wealth destruction years in recorded history. In retrospect, we all just experienced a once in a lifetime anomaly. Let's hope it's the last.
(The writer is President, Alpha Asset Management LLC, Yorba Linda, CA, alphaassetllc.com )