The 5-Month Checkup For 2008 - Memorial Weekend
I thought I'd put together a "5 month review" of my previous "Year In Review" and update anything that needed updating.
Let's start with the predictions from the "
Year In Review"
- The US will enter a recession, if it has not already done so. It will be consumer spending driven, with its genesis found in the Housing market. The slowdown will become evident once the “real” holiday sales data is posted, and accelerate into the first quarter. CHECK; real income has been negative every month since October, and real spending has been negative all year thus far.
- Unemployment will increase significantly, rising to north of 5% by the middle of next year. This will of course cascade back into consumer default rates (mortgages, credit cards, auto loans, etc) and cause yet more layoffs. The “virtuous cycle” will turn vicious. Getting there - sitting right on the 5% level.
- Housing will not turn in 2008. The total damage to prices will exceed a cumulative 15% from 2005-2008, and it will not be over. At least one, and probably several, national home builders will be cut to the single digits on their stock price or go bankrupt and be reorganized. Residential Real Estate will NOT be a buy in 2008; you’re still at least one and probably two years too early. CHECK - we have several home builders in single digits and the 15% cumulative decline is pretty much there.
- The story in the housing space in ’08 will be the defaults on “prime” mortgages – which in reality were nothing of the kind (e.g. “Option ARMs”), and on the piggyback seconds and HELOCs behind them. “Jingle Mail” will become common as homeowners that are deeply – 20% or more – underwater simply mail in the keys and say “screw the credit rating.” This will result in a near-total overhaul of the “FICO” system in the next couple of years, as these people will have defaulted on mortgages but nothing else, essentially forcing risk premiums higher for consumer credit and decoupling FICO from actual consumer credit (other than mortgage) behavior. I expect there will emerge a “shadow” FICO system which ignores mortgages but rates everything else. NOT YET; I may be a year early on this one.
- The stupidity in the rest of the consumer lending space (rollovers in auto loans and 0% balance transfer hell for plastic, primarily) will come crashing down on these companies and bring a crushing wave of defaults there as well, along with yet more downgrades in the asset-backed paper market. Starting, but not yet evident to a large degree.
- Recreational sectors (e.g. boats, RVs, etc) will get smashed. If you’re in the market for high-dollar recreational assets and have cash, late ’08 and into ’09 will present some incredible buying opportunities. CHECK - boat and RV makers are in trouble and resale prices are tumbling on both. YOU ARE STILL EARLY if you're shopping - wait!
- Government will, as is usual, try to meddle in the market’s adjustment of risk and price. The depth of this meddling will be the determinant on whether this is a deep but sharp and reasonably-short recession or whether it morphs into something far more serious. With 08 being an election year the temptation to engage in SEVERE tampering will be significant, and if they do, the risks rise materially. There is a serious risk of an all-out deflationary depression, and if we get one, it will almost certainly be the government’s fault. Whoever wins the Presidency may wish they had lost come '09 and '10. $450 billion spent on stupidity and counting; this looks on-track.
- Buffett just announced he is setting up a Municipal Bond insurance company. This will put a stake into the Monolines' hearts, taking all their business away that is profitable, and leaving them with structured finance which has huge embedded – and unrecognized – losses. The announcement, which showed up on the 28th, didn’t send shockwaves through the market – but it should have. Effectively, Warren threw a grenade (minus pin) into the magazine of structured finance. This is the death knell for the few trillion in CDSs that are out there can’t be paid; there is no longer any reason to believe that the companies writing these things will be able to be recapitalized off 'profitable' sides of their business! This is how fortunes are made (for Warren) and lost (for everyone who did imprudent things.) The 'big story' in the financial markets for 2008, and the likely trigger for major turmoil, will be the implosion of the CDS marketplace and how Buffett profited from it. This will stabilize the municipal bond marketplace which has been positively hammered. Kinda. I may be proven wrong on the outcome here in that munis may get positively destroyed due to tax base destruction.
- Equity prices will be choppy in the first couple of months and will experience a peak to trough swing of at least 20% during the year in total. I expect the S&P 500 to at least touch 1220 in 2008 and my current downside target is 1070. Note that should we get a 'parabolic' sort of move in the first quarter, which is possible, the potential for an even louder 'boom' (collapse) goes up dramatically; in that case I would not be surprised to see a three-digit handle on the S&P 500 sometime during the 2008-2010 time period. Check on the "choppy"; targets still open.
- Return OF capital will be far more important in 2008 than return ON capital. Ha! The stupidity of the pump monkeys and the public when it comes to equities is unparalleled. Nobody remembers 2000-03 - but they will.
- I do not expect the central banks to “hyperinflate” anything. Metals, in a protracted, serious deflationary selloff will get smashed.
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