Tuesday, December 16, 2008

13 Outlier 2009 Predictions

In the spirit of hedge fund manager Doug Kass' annual outlier prediction list [Jan 2: Doug Kass 20 Predictions for 2008], last year I decided to write my own. You can read my 13 Outlier 2008 Predictions here [Dec 31, 2007: 13 Outlier 2008 Predictions] and a self assessment this past October [Reviewing Our 13 Outlier 2008 Predictions]. Ironically, Mr. Kass and I actually had a lot of similar calls for 2008, although I posted mine first (and I do so again this year so it doesn't appear I am stealing ideas) Even more funny, we both went wrong on the same ideas (major home builder failures, a bubble forming in tech stocks, etc) It was very strange how the ideas were very similar so I'll be curious what this year's list brings and I'll post it when it comes out in a few weeks - I did less on the stock market, and more on economics this year.

Keep in mind the idea behind these lists are not consensus predictions but potential outlier events that theoretically, if they come to fruition, could provide some out of the box money making opportunities. Of my 13 2008 Predictions through October 2008, I graded myself 80% or higher on 7 of them - with 3 complete misses. The other 3 came to fruition to some degree. Considering the "outlandish" nature of some of what I thought a year ago, and the environment in early winter 2007 (keep in mind this was before the Federal Reserve began any historic actions, before Bailout Nation ensued, before Bear Stearns, SocGen, et al) and the historic nature of the year we just witnessed, many were remarkably spot on.

Once more, this list differs from my economic thought/roadmaps which I update every so often - the things I truly believe have high conviction will happen - even if those, many times stand different from the crowd - my latest is found here [November 2008 Thoughts & Roadmap] My track record on earlier economic predictions of this nature is running closer to 90% success. [December 2007 Thoughts & Roadmap]

One note: the economy and the stock market are two different things; despite the "darkness" of the outlier events listed below keep in mind they should be (a) outliers and (b) even if they come to fruition, the stock market will eventually assimilate the bad data and then look "forward". I could make a case that by 2nd half 2009 a very positive investing environment may emerge. But that's Wall Street, not Main Street.

Since it is hard to remember the "environment" a year from now, I've tried to write within most entries the current "consensus" or claims by the financial punditry.

#1 Housing Mortage Market: I've spent the last month working on this entry piecemeal as I think through theories and decide what topics to discuss and which to remove to limit myself to 13 topics. Unfortunately, for topic #1 - housing - the government has already begun their act so I'm already looking late to the game with what I was theorizing. I've already begun laying out this prediction in earlier pieces the past few weeks, but let me put it all in 1 spot. After the mere mention of buying serious amounts of mortgage backed securities dropped the mortgage rate from the low 6s to middle 5s range, I saw the light - these guys were going to buy mortgages until they can semi-reinflate the housing market. My inclination at the time was the Federal Reserve would just buy, buy, buy (assets that, based on their quality, have no place for their balance sheet of course) mortgage backed securities until they engulf the market and get rates to mid 4%s. But it appears the Treasury is going to come out of left field to help them based on the things that are floated - so this one two punch could be even more serious than I imagined on rates. Can you imagine the bubbles we shall create with a potential sub 4% 30 year mortgage rate? But larger than that - my prediction is Fannie/Freddie and then above and beyond that, for people who do not have 20% down and won't pay for insurance, the FHA - will wage a war against current mortgages. We'll see interest rate buydowns, we'll see principal reductions, we'll see anything and everything that basically gives a big (bleep) you to people who have been honoring the system. In return we will tell those people, well if your neighbor's house goes into foreclosure we will all suffer, so it's a necessary evil. By the back half of 2009, refinancing will reach levels (and above) seen in the bubble years of 2005-2006. Obama & Co will also come up with myriad plans for buyers to suck up excess inventory - the government will be our partner. Nothing should surprise you - this will be an all out assault - we are already seeing the first inane ideas such as no appraisal refinances. The "private" mortgage industry will be almost completely crowded out as no one can compete with what the government will offer.

#2 Housing - Prices & Stocks: Since housing has been so central to our vortex of pain, I'll devote two entries to it. While most of the government initiatives will be focused on existing stock of homes, the "free market" advocates that live on Wall Street will clap endlessly in the socialism that washes among us, and housing stocks anticipating a "bottom" in (a) spring 2009, (b) summer 2009, (c) fall 2009, (d) winter 2009-2010 will be driven up continuously (and then fading as no bottom is found) - but in the back half of 2009 housing stocks will be among the best performers in the market as investors anticipate the 97th housing bottom, that of spring 2010. (sort of like the great housing bottom sold to investors in 2008, but just 2 years later) Contributing to this optimism will be the fact that after housing prices fall sharply in 1st half 2009, they will begin to fall "less" than previous periods in many of the hardest hit areas in the 2nd half of 2009. After all, 40% year over year drops just cannot continue forever. Even as job losses accelerate, and the natural cycle of a housing cycle begins in earnest - so much damage has already been done to prices that eventually the rate of decline shall slow. Wall Street, looking for any glimmer of hope, will step on the gas in pushing early cycle stocks on the first reports of housing prices falling as a smaller percentage year over year than the previous month/quarter. With the "generous" government mortgage rates created from prediction 1, this should happen by summer 2009. This won't be a bottom - we'll skid along the "bottom" for many quarters, and prices will continue to falter, but decelerating loss in prices are all Wall Street needs to drink gallons of Kool Aid. 4 to 4.5% interest rates, all things being equal, will of course help but many Americans will continue to sit on the sideline due to mounting job losses and the asset they are targeting (home prices) continues to fall, so who wants to buy an asset that seems to go down month after month? But, it will help on a relative basis.

#3 Unemployment: Similarly, the bulk of "heaviest" job losses shall be completed by summer 2009. We will continue to see job losses throughout the year, but Wall Street will once again be 'heartened' by the same game seen in housing prices - a 300K job loss number is better than a 500K job loss number. The rate of decline shall lessen in the 2nd half - enough for giddy bulls; but job losses shall continue on - staggering Main Street. The losses seem in the first part of the year will be eye opening - we've just seen our first weekly unemployment claims >550K. We will see a >750K weekly unemployment claim by Easter. Government unemployment reports understate reality but even the government unemployment rate will flirt with double digits by Thanksgiving 2009. The stimulus plan by Obama will help put construction workers back to work, but the structural imbalances in the system are far too great to make a major dent in what approaches.

#4 Retail: To that end, 5 major "name brand" bankruptcies will occur in national retail chains by Memorial Day 2009; these are names even the casual shopper will know (ala Circuit City). America will continue "right sizing" it's overbuilt retail space - unfortunately, the real damage will be unseen as it will be in the scores of "mom and pop" 1 off retail establishments. Strip malls in many communities will sit 1/2 empty. A sampling of traditional malls across the country shall shutter as vacancy rates increase substantially. The right sizing shall continue in the automotive industry - I said in 2007 that 2008 would be the worst year in 2 decades for car sales; 2009 will not fare much better - 11 to 12M is the new 16M in annual car sales. The level of car sales we've seen the past half decade were based on a society sucking equity out of homes; along with easy credit. Neither is coming back in 2009 - the net result will be 3000+ car dealerships closing their doors - damaging many smaller towns and communities. The restaurants space in the mid to upper end shall continue to suffer; more chains will close. Media (while not "retail") will be another area of large suffering; the wrenching downscaling in newspaper and magazines will only accelerate. See the commentary in sports about ad spending...

#5 Bailouts: We've made very clearly for a year and a half now that state budgets would be a complete disaster in the coming year. With a cloudy crystal ball considering what Obama will do in terms of individual state stimulus it is hard to make a call here; frankly aside from Orange County in the early 90s a municipal default was as rare as a dodo bird. But without federal government aid, we will see the threat of a bevy of them. If there was no federal government bailout this would be my call but as with all things - the level of government intervention makes predictions difficult. Instead, we'll say as it becomes increasingly clear that states and local government agencies have to pay higher fees on bonds to offset their growing risks - a situation they can ill afford, the Federal Reserve will add municipal bonds to their growing litany of backstops adding to the $8 trillion already "guaranteed". Since the market believes the Federal Reserve can backstop everything in the entire nation; this will reduce borrowing costs for said local entities. As for stimulus, as I hinted above - we will have housing, multiple auto, education (loans/K-12 schools) and state directed bailouts in 2009 on top of our much anticipated early 2009 "New Deal 2.0." I'm not sure when the world markets see where this is heading and punish the dollar but it has to come at some point...

#6 Sports: We said in 2007 that sports will begin to take their first hits in 2008; 2009 will be far worse. As ad sponsorship of all types (hello cars, hello banks) dries up - those sports not already locked into lucrative long term TV contracts will see sizeable hits. NASCAR will lose a good amount of sponsorships, and a handful of races will be cancelled in 2009. The LPGA and potentially even PGA tours will cancel tour dates. The NHL, without said "major" TV contract, will be facing serious trouble by late 2009. Ticket prices across the landscape will flatten and indeed in certain markets begin to fall as stadiums start to see 70-85% capacity; both the "Average Joe" and corporate ticket buyer will be a scarcer commodity. Again, TV contracts will buffer the Big 3 sports (baseball, football, NBA) to some degree so I cannot yet call for a stagnation in median salaries. Instead, the have and have not system - stars versus average players will widen - no different than Americans as a whole. A greater percentage of league revenue will go to the salaries of the very few at the top. A disconnect will occur between salaries and the economic models ex-TV (gate receipts, concessions, et al) and fans will the first time in years begin to raise question about salaries after years of "well that's how sports are- we just accept it".

#7 Social Mood: The social mood will worsen as the difference between have and have nots accelerates. This has been a growing situation simmering under the surface for a decade as median wages (inflation adjusted) have stagnated, while "costs of life" have accelerated. The national mood will switch from a consumption culture to embracing thrift as a "status symbol". People will be shocked at how quickly this changes from the exact opposite in 2006-2007. The rich will pull back from the most obvious egregious spending as the social mood of the nation shall frown upon it. (this won't mean they will stop doing it; it just won't be celebrated as it has been the past few decades) Crime will rise in a substantial way in most major cities as the unemployment rate rises tremendously among the young, minorities, and disenfranchised. Again, something simmering for years but more desperation will expose these things. Despite ultra low mortgage rates, out of economic necessity a growing trend will be afoot for families to move together under one roof to maintain economic stability (parents moving in with adult children, adult children moving in with parents). More scandal of a high order will be exposed in the business world as the tide continues to pull back exposing some of the ugly that has been hidden within the system the past half decade. On the positive side, banding together as communities to help neighbors out will also be on the rise. Celebrating personal relationships over "items" will make a return for the first time in a long while on a national scale. President Obama, who can speak in an articulate manner and talk about long term "big picture" national plans will shock Americans, who have forgotten a political leader can actually act like this. He will enjoy sky high approval ratings and a sense of optimism shall pervade early in 2009 as we turn the corner from what preceded him. (but as Main Street continues to take hits in latter 2009 the halo around Obama will falter to some degree as "reality" trumps "hope")

#8 Food: with the lack of investment in farming caused by lack of credit and input costs rising to a level that many 2nd and 3rd world farmers cannot afford; another food crisis shall emerge this summer when inopportune weather hits. Reports of localized hunger and shortages will hit in a few waves in countries most Americans could not pick out on a global map. With global economies in worse shape than they were in 2008 when the last crisis occurred, trade protectionism (food and otherwise) will rise sharply as each country thinks to defend itself first and foremost. World politicians will speak out against protectionism, but then do their typical about face and practice the opposite of what they preach.

#9 Hedge Funds: We said in early fall than as many as 25-33% could close their doors by Dec 31st, 2008 as the inability to get paid on the 20% portion of profits ruins the business model. Realizing that no profit can be made without reaching the annual high water mark (no profits made until investors with losses made whole) - a new model emerges emphasizing a rolling period of returns - most likely is the 3 year model. Ironically, this would actually be a much more healthy thing for the entire market as the running and gunning for monthly returns and hitting X% every year would lessen, but this has nothing to do with health; it has to do with self preservation. Another wave of closings will occur by summer 2009; and friction emerges in a large way among existing hedge funds and in fact hedge funds and their enraged investors for the "lock ups" and "gates" imposed through latter 2008 and 2009. By end of 2009, fully half of hedge funds will be gone.

#10 Private Equity: Multiple deals that were created in the years of credit excess will follow the Tribune model and implode. Many newly unemployed in what would have been otherwise "alive" companies, suffer from the debt bestowed upon the entities by the titans of private equity. What 2008 was to hedge funds, 2009 will be to private equity. Congressional hearings will begin in earnest and a palpable public anger will ensue that, much like banks, private equity came into functioning companies - impaired their business model with layers of debt, and extracted huge fees (along with the investment banks for "consulting and transactions"). 2009 will be the year the private equity model is attacked; the "deal makers" will become a public enemy.

#11 China: As the government is desperate to cut social strife at the knees, the Chinese government will launch a series of pro-growth stimulus over and above what has already been announced. Despite government figures to the contrary, Chinese growth will be far weaker than the consensus today believes for the greater part of 2009; especially Jan-Jun. However, by late in the year - the knock on effects of new rounds of stimulus should light a fire under commodities. If lightly used roads to nowhere need to be built to calm down the 100M+ migrant workers, they will be. All things being relative, China will be in better shape than others, but it won't be a pretty year and "decoupling" that the consensus once again is preaching (as they did in early 2008) will be premature for most of 2009.

#12 Wildcard/Europe: Potential defaults on debt arise in a host of smaller countries - especially of the Eastern European variety. I don't know which ones, but they have been mini U.S.'s, borrowing over and above their head, but unlike the U.S. do not enjoy the fact the entire world rushes into their debt market when a crisis emerges. The opposite will happen - Iceland & Ecuador are just the precursor. Russia, if low oil prices persist, invades another former satellite country both as a nationalistic reason (diversion to the populace from worsening domestic conditions) and to try to light a fire under European natural gas, and/or oil prices.

#13 Budget/Bonds/Fed: Consensus is that the United States will face it's first trillion dollar deficit in budget year 2009 (Oct 1, 2008 - Sep 30, 2009). That is excluding the war since we don't consider the war an expense but much like our banks an "off the balance sheet" accounting "figure". The largest postwar budget deficit has been $413B in 2004; hence consensus says we are about to do 2.5x the largest previous record. I say it will be 5x the previous record and not only will we have our first $1 trillion deficit, fiscal 2009 will be so poor we will have a $2 trillion deficit. The consensus today is bonds are in a bubble (I myself have bought the ETF that bets against bonds); we just saw intraday negative interest rates on the three month T-Bill. Our 10 year bond pays 2.59%, the lowest since the 1940s. With Japan paying 1.4% on its 10 year bonds and the US not much different than Japan, I will make my final outlier prediction of the year that 10 year bond rates fall even further - potentially 2.20% or below, and 3 month T-bills go negative and stay there for a sustained period of time in 1st half 2009. That is, people will pay the U.S. government to borrow money as "signs of recovery" are lacking by spring 2009. The Federal Reserve balance sheet will grow from $800Bish last year to $2.3T as I write this, to $5 Trillion+ at the peak in 2009 - literally the country's economic engine will rest on the Federal Reserve. This period we visit in 2009 will be the highest stake financial gamble ever taken on in history - either we reinflate the world with US dollars or we default. Let's hope it works - essentially the full faith and credit of the U.S. is all that is at stake. If does work, we now lay down the groundwork for the next bubbles of 2011-2013.

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