The pattern continues

Don't count on "Change" to help the Stock Market

The pattern continues. Just a few days before a long weekend & the presidential inaugural, the banking system came close to another meltdown, only to be saved by the Federal Government, again, another in the ongoing, rolling, systemic failure of the financial system. Its now clear that CitiGroup has failed & has essentially been nationalized. BofA must have notified Treasury that the Merrill deal was in jeopardy as the losses would be too big for it to absorb, or just decided it was the right time to play its hand for a government deal like JPMorgan got for Bear Stearns, so Ken Lewis got the Jamie Dimon package of government guarantees & backstops in order to takeover Merrill Lynch & its rotting debt portfolio. Neither is a good thing & neither will spur demand for borrowing.
Both incidents point to the unmistakable fact that the financial system is still fragile & all the efforts to date have NOT resolved what is wrong. The government has again stepped in front of the market right in the nick of time to defend against further equity market declines. The only difference this time is that they did it during normal working hours rather than on Sunday night....probably a scheduling conflict with the upcoming inauguration.
Now market players are focused on Tuesday's inauguration of President Obama. While that event will be inspiring & exciting, it will not spur a pick up in economic activity, except in Washington DC. Many 'hats' are being hung on the change that is coming, especially the economic recovery plan, hoping that the bulk of the change comes in the value of stocks & homes.
The unfortunate reality is that the new president will be hard pressed to create robust economic activity, regardless of how much change he ushers in. The dismal economic situation will endure for quite sometime, probably six months minimum. The economy is in a downward trajectory due to all the bad things that have occurred & that will not reverse quickly. President Obamas first 100 days, which ends May 1st, will be filled with historically weak economic & corporate reports, ongoing municipal & corporate downsizing, & continuing consumer retrenchment.
If congress acts with urgency, it will also be punctuated by a trillion dollar stimulus plan, the equivalent of a defibrillator electric shock blast for a heart attack victim. When economic activity does stabilize, stop declining, the recovery will be a long process that will not lend itself to a sharp & steady upturn. Rather it will be slow & laborious, starting & stopping many times as the various government assistance, supports, rescues, bailouts, zero rates, & stimulus work there way into the broader economy. The repair & recovery of our impaired economy will take a very long time & to expect anything different is just hopeful.
Don't count on President Obamas promise of Change to alter the facts & reality of our economic predicament or to make the stock market rally, especially in the nearterm.

Shoes To Drop In 2009

2008 was a very eventful year filled with many manmade & natural disasters. Stock market participants suffered torrential shoe storms, getting hit on the head many times throughout the year with so called 'shoes' dropping, sometimes they came in pairs. After each historic shoe event, the question was... will more shoes drop & from what closet will they come?

I'm here to give fair warning that there are more shoes to drop, some coming from closets we aren't even paying attention to. Arguably, we should all be prepared & ready for these shoe showers, as the economic data & corporate reports are foreshadowing more weakness that will last for a longer time. With that backdrop, here is my 2009 shoe drop forecast.

1) Commercial Real Estate is going to face the same challenges that the residential housing market went through & continues to go through...except it will be worse. This shoe has implications for banks & insurance companies as well as the commercial real estate developers, both public & private.

2) There will be at least one automobile manufacturer(GM) bankruptcy by early spring. If this shoe drops, a second automobile bankruptcy (Chrysler) should follow shortly thereafter. And, a European automobile manufacturer could also go into Administration as well.

3) Corporate pension plans will show a big problem. Specifically, most if not all corporate pension funds are significantly underfunded & will require companies to shore up those pensions using up vitally needed cash.

4) Private Equity will suffer severely as funding continues to be very difficult & operations of the businesses will be impacted by the recession & will require capital. In addition, the IPO market will provide no relief for P/E to monetize investments & exit businesses.

5) Hedge Funds will continue to face redemptions & underwhelming performance. This will continue to pressure the markets & reduce liquidity. It will also impact the brokerage industry.

6) Municipalities all across the country will face huge budget deficits & will be forced to cut services & raise taxes. A major municipal default will occur before year end.

7) More small & mid-sized bank failures will occur...these will be the flip flops of the shoe storm.

8) The housing depression will conitinue as prices continue to fall & demand for homes does not materialize even with all the government programs being put forth. Housing inventory will rise to historic levels. at least one major homebuilder will go bankrupt.

9) There will be at least one, more likely many, major retail bankrupcty and at least one major commercial retail landlord, REIT, will go bankrupt.

10) Warren Buffets Berkshire Hathaway will face the slings & arrows of the ongoing economic weakness & financial crisis. The stock will be cut down to size...maybe $50,000/share or so. The legendary CEO Warren Buffet, having just won the CEO of the year award for 2008 will be unable to defend his empire from the current economic situation. As with many other pillars of the financial markets & wall street, it would only be fit for the company to show its vulnerabilities and succomb to the forces that have impacted every company in every business that Berkshire Hathaway owns or operates.

As you can see, the closet is full & the shoes are ready to drop...heads up.

Frugality is the New Black

Thrift & savings are back in style. No longer will you look at others in envy of their luxury & excess. Most will want to hide, and preserve, whatever wealth they have hoping it's enough for their later years in life. Whether you have (had) money or not, you won't be questioned about your thriftiness, you will be acknowledged & admired for it.

There is a SECULAR change happening. The theory of "if we advertise it they will buy it" is being challenged. The common notion that Americans will continue to consume at a rate well beyond their needs & ability is being forcibly changed.

The American psyche about how & what they need, want, desire...consume is changing. The concept of ever growing prosperity & entitlement has been replaced by a fear of having less & living a lower 'standard', maybe even not keeping up with the Jones'.

The damage of a generation of profligacy & excess is done. It is apparent that the baby boom generation, for all its good, has left an indelible mark on our country's financial health & has jeopardized its own retirement years. The next generation is watching & hoping the financial damage can be fixed before they retire. And, the younger generation is watching in horror & preparing carefully to make sure they don't end up with an even worse financial situation.

None of these 'generations' has lived "like their grandparents" did. I remember my grandparents always asking why we needed this or that or why we weren't using something longer or more thoroughly...you know, to "get the most for your money". That wasn't part of our thinking. IN fact, most of the time we were getting very little for our money, and didn't really care much about it. We thought their would always be "more where that came from".

My grandparents were always trying to "get the most for their money". We would mock them for their thrift & frugality...joking that they should stop being so cheap & enjoy their money (spend it). Well thank goodness they didn't listen to us, because when the passed away they had something left, which we got & enjoyed (spent) in short order.

The current economic situation has created a new dynamic. Wealth has been destroyed & careers have been interrupted. Every socio-economic class has been impacted. The government is trying everything to fix the situation, but we all know what has happened & that the future is going to be different. Changes are being forced upon the entire American population. Consumption behavior has changed & will be very different going forward.

The implications of this secular change in consumerism are enormous. One good implication is that in 5-10 years, we will have rebuilt our savings & financial security. Near term, this will cause considerably more economic damage in order to resize our retail complex.

The boom times have created a hugely overbuilt retail complex...from the manufacturing & supply chain to the marketing & store base...all of which will have to be 'downsized', some wiped out completely. The days of relying on the all mighty US consumer are over. Frugality is the new black.

On A Slope Of Hope
Its the bear markets version of the wall of worry, which most financial pundits point to for a bull market to climb higher. As with most bull market mantras, there is an opposite, and sometimes more destructive, bear market version. That would be the "Slope of Hope"...which we seem to be on. As investors enjoy the recent stock market bounce, a dangerous calm has set in. All the new & improved stabilization actions taken by the government have again slowed the decent in stocks, but the damage is upon us & will continue to be reflected in the data & the healing is far from done. While it 'feels' like the market has stabilized & is shrugging off some pretty difficult economic & corporate newsflow, this stabilization is tentative at best. Real bear markets, and that's what we are in, tend to drag a bit...rather than spike down & rebound sharply, only to begin rising steadily. Instead, each tumble lower is met with a bounce followed by a bit of stability, before lurching lower...and then repeating. Disenchantment, disinterest, & disengagement sets in...CNBC might even stop asking you "Is Your Money Safe?" & "Do You Know Where Your Money Is?"...that would be a tell of sorts. Then it goes dead for awhile as investors recover & readjust to a new economic reality & net worth. I think we remain firmly on a slope lower...with a crash only prevented by the hope that the worst is behind us & the leaders are going to be able to reverse the economic slide. That hope may soon be replaced by worry followed by despair.

Madoff Fraud Fallout...Emotional, Psychological, & Financial, not necessarily in that order
From Manhattan to Long Island to Greenwich to Palm Beach to Aspen to London to Zurich, high society has lost billions of dollars & an immeasurable amount of faith & confidence. When belief in something gets shattered, it takes time & double the amount of proof to restore it. The Madoff Scam, ponzi scheme, fraud, whatever you want to call it, has destroyed decades of belief in not only mr. madoffs investment operation but in the confidence of the entire investment & hedge fund industry. Only time will tell the consequences of this latest blowup, but this could certainly mark an important point in the financial industry's history.
It harkens back to the great depression period when secretive & profitable Investment Trusts were all the rage & boasted high returns with seemingly little risk. They were designed for & catered to the wealthy, but towards the end of their greatness they opened their doors to all investors. Their demise was a part of the financial collapse of that period.
Today, With fund of funds now getting the regular guy involved in the big guys game & all the major brokerage houses & investment banks having 'alternative investment vehicles' (driving the investor to who knows where) to help smaller investors get access to previously closed hedge funds, most everyone is involved or exposed to the hedge fund world. The hedge fund industry has grown exponentially over the past few years & some have pointed to the possibility of a hedge fund bubble. Who knows, maybe its bursting as we come to the end of 2008?
Whatever the case, it is clear that this is another severe blow to investor psyche & wall streets credibility. With huge losses in most all investor portfolios, adding the revelation that an enormous fraud has been going on at one of the most well regarded & long established investment funds will certainly create further problems.
Investors large & small must question all their financial relationships & investments. Investors must now redouble there due diligence efforts in an attempt to insure & assure that their money is safe. Fiduciaries will be questioned & challenged to provide proof positive that all is well with client investments. Clearly the madoff news proves that nothing can be taken at face value & no investment is safe.
Investors continue to watch small banks fail, while the government injects life preserving capital to the large, too big too fail, banks, which would have failed without the government intervention, questioning the safety & soundness of the financial system almost on a daily basis. Now they are seeing the best known & most highly regarded hedge funds report astounding losses & gating investors from their money. Now this madoff madness. How can investors not question all the belief, faith, & confidence they have in the markets, their advisors, & their investments?
There is amazment & outrage. This is terrible for investor psyche, very very damaging to investor confidence on top of huge loses everywhere, in what investors think & hope are legitimate operations. The next round of redemptions could be multiple times what we have seen through year end. This could be another serious & ominous headwind for the stock market.
And it won't help the economy either. The wealthy are being damaged irreparably by the magnitude of the wealth destruction taking place and it is not going to reverse anytime soon. Whenever the recovery comes, it will not replace what has been destroyed, the money or the confidence.
The economic weakness is going to intensify from the very top. The wealthy will 'withdraw', literally & emotionally, from investing & consuming in a significant way for a significant period of time. The 'trickle down' impact will be devastating to the overall economy. The ripples that are sent out from the from this part of the economy touch many parts of society. The wealthy are industrial consumers & do the majority of the risk taking investing. Damaging their ability or desire to do those things will have far reaching implications. From luxury retail to charitable organizations, the wealthy have an important economic impact. And must, pardon the phrase, maintain their standard of living so that the economy doesn't implode.

THE AMAZING DEPRESSION
I always wondered why they called the depressionary period in the early 1900's "the great depression" as it was a horrible period of time. I just figured it was one of those oxymoron things. Yet, after learning about the the depth & breadth of the financial collapse & subsequent economic downturn I came to understand why it got the name & why it was appropriate, even if it was an oxymoron. The Great Depression was just that...great in its devastation of the economy & its impact on Americans lives & the country at large.
It seems apparent to me that we are currently on the precipous of the next deep & long period of economic distress & weakness. What we call it is yet to be determined as we are just first acknowledging it. As of early last week the NBER, which is charged with the duty of calling & marking recessions, its official that we are in & have been in an extended period of economic weakness...sometimes referred to as a recession. Others are still waiting for the text book example with two consecutive quarters of declining GDP, to admit the obvious, but statistics aside, we all know where we are & what is happening.
Now for the naming of it. So far, the best I've seen is "The Great Recession", which is referring to the fact that this economic weakness is now being seen to have began in December 2007, making this recession a full 12months in duration (so far we have only Q3 2008 at a down 0.5%, hardly a decline at all according to the data)& most are looking for it to intensify this quarter (Q4 2008)& for it to last through at least the middle of 2009 (Q2 2009). That would make it an 18+ month long recession, which is much longer than the average 10 month recession & longer than the 16 month weakness of the longest recession on record.
While I am in agreement that the weakness will last longer then usual, I am not so sure when it will end or how we will emerge from this extended period of weak economic activity. In fact I see many things that could make for an even worse forecast, something like a depression, defined as an 'extended' period of declining GDP growth lasting longer than two consecutive quarters.
If that were to happen, everyone would be amazed. Amazed that it could happen again even though we have learned from the past & have experts in charge looking out to prevent just such a scenario. I think its very possible that this generation is about to experience the biggest "come down" in the country's history. And I offer what it should be called... The Amazing Depression.
It will be amazing from many standpoints not the least of which will be how could this happen even with all expert knowledge of the first depressionary experience. Amazing that it occurred even with all the heroic efforts of the FED, Treasury, regulators, & congress trying to prevent it from happening. With Bernanke being the depression historian & having the hindsight to be proactive & learn from past mistakes. With Paulson's wall street smarts, unorthodox & inventive actions he has initiated to halt the momentum towards the abyss. With Congress nationalizing entire industries while doling out trillions to arrest the financial collapse. With regulators on the job with creative tools to manage the market participants. And the president continuously pointing towards positive & productive resolutions to the economic malaise. Still we head towards further economic weakness & uncertainty with the financial system seemingly broken.
As hard as it is for us to believe & accept, we may very well be in for that dreaded extended period of declining economic activity, also known as a depression. The powers that be are on the job & working feverishly to prevent that. Much of what is being done has never been done before & so the results & consequences are unknown. It is painfully obvious that so far at least, all that has been done has not worked to arrest the economic weakness from getting worse.
Going into the year end of 2008, a historic year on many fronts, not the least of which will be the crash of the equity markets here & around the world. 2009 will be greeted with further terrible economic data & corporate downsizings. Hopefully Barak Obama will be able to lift our spirits enough to overcome the financial hardship that looks poised to impact rich & poor alike. Businesses are bracing for the most significant economic reorganization of the last century & government is prepared to put in place rules & regulations to make sure this will not happen again...another really bad thing.
The trillion dollar stimulus of the new millennium will be set forth & the US will try to lead the world from the brink of financial & economic collapse. If it doesn’t work, we will be in the midst of what may be called..... The Amazing Depression.