Dave Wright 2008 Market Outlook p.1
Tom Petruno New Year’s Forecast for 2008 p.2
Don Gimpel Education Insights p.4
2008 Market Outlook
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By William Parmenter, Editor
Year 2008 got off to a blazing start on Jan. 12, as two top-rated speakers gave spellbinding talks on the depressing market outlook for 2008 to a capacity AAII crowd at the Skirball Center.
David Wright, Managing Director of Sierra Management Inc. gave the first talk on “Uncharted Waters, Trends and Outlook in the Economy and Global Investment Markets.”
At the conclusion of the talk Wright was awarded a plaque for 25 years of outstanding service to the AAII Los Angeles chapter on behalf of the chapter by outgoing president Orvis Adams.
Wright’s talk gave a general picture of the economy, indicated places where the prudent investor could put his money, and drew conclusions about the recessionary and second phase of the secular bear market ahead.
Regarding the economy, Wright noted that home prices soared since 1990, with the average home price being up 150 percent. This created a home price bubble that was unprecedented in the last 107 years.
At this time homeowners can no longer extract equity through refinancing. Those mortgage equity withdrawals accounted for almost all of the economic recovery since the 2001 recession.
Now there are an unprecedented 1.2 million vacant and under construction homes.
The slump in housing starts has caused related employment to collapse. In the latest 10 years a bubble in credit derivatives has grown from zero to $45 trillion.
Americans are no longer saving, but rather spending more than they earn. Spending has been fueled by consumers taking on additional debt, which has risen to 115 percent of disposable income.
Existing adjustable rate mortgage defaults are set to explode, with one to two million families due to lose their homes.
Corporate loans have soared in the latest ten years, creating a global debt bubble. Mortgage defaults are just the most visible tip of the iceberg. Under the surface there is a huge global debt bubble, plus $70 trillion in derivatives.
This bubble will take several years to unwind and pose a risk to the banking system. Over the next two years several trillion dollars in mortgages will ‘reset’ with about half defaulting
Major firms like Deutsche Bank, Morgan Stanley, Barclays, Citigroup, Merrill Lynch and Bear Stearns, among others, have been hit hard by sub prime loan defaults.
Of $300 billion sub-prime loans packaged in 2006, 16 to 24 percent have already defaulted. Fannie Mae and Freddie Mac are on shaky ground and may become insolvent.
Inflation has been systematically understated by the government. Crude oil prices tripled in 3 years to 2007, and now are on the rise again to $100 barrel oil. Food is up 70 percent since the 2000 low.
Health care, energy, food, housing are all way up, so the 3.5 percent inflation figure is too low. Total inflation is rising much faster than core inflation.
Employment is faltering. Since 2001 employment grew less than the population. It takes creation of 150,000 jobs a month to keep up with the growth of population. Payroll growth is way below the growth of labor force.
U.S. consumers drive both our economy and much of global growth. Now the consumer is overextended, and cutting back and can no longer use his home as an ATM. The cutback will gradually impact the European and emerging market economies. Consumers are now scared.
The cyclical recovery is now over. The economy is going into recession and the second phase of a long-term cyclical bear market. Potentially the recession could become the worst since the 1930s.
Evidence for recession include: the yield curve went negative, leading economic indicators predict recession, and an econometric model is now bearish.
With a declining dollar, and a negative outlook for equities, where can one invest?
High grade bonds could really soar. A choice would be Pimco Total Return fund, which has a 20 percent up slope since 2007. Since 1998 Pimco Total Return provided total returns equal to those of the S & P 500, without the volatility.
Among other choices could be Pimco Low Duration III, which has a 13 percent up slope since mid-2007. One could buy a money market fund, which, surprisingly, has performed about the same as stocks for the last seven years, at about 3 percent.
Then, one could pick a high-yield muni bond fund, which has outperformed the S & P 500 over the last seven years.
Commodities and energy are two asset classes that look promising; as does betting on a declining dollar, or on the Euro appreciating.
To summarize: the economy and the stock market have completed their rebound cycles and turned down. The outlook for both is now negative.
The U.S. economy has now apparently begun a recession. U.S. consumers are retrenching, in the prospect of a bad recession.
The secular bear market in stocks may have begun another multi-year down movement. In this phase of the economy, avoid high yield corporate bonds and reduce your allocations to stocks and other risky assets.
Consider investing in various durations of high-grade bonds, high yield municipal bond funds, inverse dollar fund, and commodities.
2008: The New Year’s Outlook
By William Parmenter, Editor
Tom Petruno, Senior Markets Editor, for the Los Angeles Times, was the second speaker at the Jan. 12 Skirball meeting, addressing “2008: The New Year’s Outlook for Domestic and International Markets and Economies”. He spoke to an enthusiastic, standing-room only audience.
Commenting that the Skirball date was his favorite speaking engagement of the year, he immediately distinguished his presentation by saying he was not as bearish as David Wright had been.
Petruno began by taking a look backwards at year 2007. At the beginning of 2007 the biggest challenge was what to do with the global glut of capital. The idea of risk seemed quaint. “Risk was contained” was a mantra of the Fed and the Treasury. Contained where…in the solar system? Petruno quipped.
In midyear came the change. Risk became real. After mid-August no one was talking about a capital glut. After that came periodic market panics, pauses and panics. We entered a seriously bipolar market world.
Entering 2008 we feel unsettled. There is a lack of certainty. The housing bust is ongoing. How bad can it get? It was the greatest housing boom in history, so expect a huge bust.
In the wash of the housing bust expect to learn that there was a huge amount of fraud. Think Tyco, Enron and World Com of the dot com bust. It is too early to see all the fraud that was involved, but it will come out.
Unlike the dot com bust, the housing mess touches everyone. Homeowners, lenders and financial institutions are going to be taken down; how many is unknown.
The housing recession will lead to an economic recession. Last year’s theme was that the economy would be saved by exports; it led to the destruction of the dollar. We are close to the edge of a serious recession.
What can the Fed do except throw money at the problem. The Fed will lower interest rates; it is all that it can do.
This is a credit market problem, not a stock market problem. Most stocks and corporations are bystanders. But the problem spreads and stains through the economy. To put the matter in perspective; this is not the big one.
Selected stocks will do better. The 3.1 percent return on Treasury Bonds is not enough to cover inflation and future liabilities.
The bond market is about safety. High quality bonds are a good place to be, for example, Pimco.
It is dangerous to get out of the equity market, because you might not get back in. You have to be in the market to take advantage of the random few days a year when the market shoots up.
The market is the great humbler. We will never be smarter than the market. Read Warren Buffett’s annual letters to his shareholders; he talks about his mistakes.
Some key points:
1)A giant wealth transfer is going on. You have to be invested in foreign equities. The Iraq war has got to be making the Chinese happy, as it is costing us a trillion dollars and giving them an opening to make business deals around the world. The U.S. as a nation is becoming poorer. But it has too many assets and well-educated people to become poor.
2)We are seeing a return to large caps and a decline of small caps. There is a new respect for companies with financial strength. People are buying quality, high grade bonds and munis.
3)Taxes are going up in the next few years. California and New Jersey have budget crises.
4)How are we going to pay for the health care liability? Pension funds feeling pressure to improve returns may start investing in commodities.
5)Commodities have had a seven or eight year run, following a 20-year bear market. Commodities will continue to be strong. How high can gold go? Factoring in inflation, gold would have to hit $2,200 to be equivalent of the 1980 high price of gold of $873. People wonder about gold’s intrinsic value; Petruno thinks of it as a relic.
6)Diversification is crucial, as one cannot know what the best asset class will be for the next five years. People need to learn the lesson of diversification. You need to have a little of everything. Cash is a no risk asset, so it has a zero return.
In the question and answer session to his talk, Petruno pointed out that that people in the U.S. over-consumed in the last 20 years. Now the bills are coming due, especially in the housing area.
People were sold houses that had no job, no income and no savings. People will lose their homes and their savings too (their home equity). This is happening at the margin. The core situation is that most people continue to pay on their mortgages, and some people own their homes outright.
Education Nuggets
By William Parmenter, editor
Don Gimpel, AAII’s one-man education committee (consisting of himself) presented five minutes of insights to introduce the AAII meeting at Skirball Center on Jan. 12.
Gimpel talked about mapping country GDP equivalents by comparing them to the output of states in the U.S.A.
A U.S. map was put up on the screen. In the place of the state names were the names of countries. Each state had the equivalent GDP as the country whose name was in the state. For example California has the GDP of Brazil; New York has the GDP of Indonesia; and Texas has the GDP of Mexico.
Other GDP equivalencies are as follows: Pennsylvania to South Africa, Illinois to Argentina, Michigan to Hong Kong, New Jersey to Switzerland, Ohio to Thailand, Florida to Austria, North Carolina to Taiwan, Arkansas to Egypt, Georgia to Sweden, Virginia to Saudi Arabia, Minnesota to Ireland, Arizona to Israel, Kansas to the Philippines, Indiana to Finland and Oklahoma to New Zealand.
The map provided food for thought, showing how powerful the economies of the respective states are, and how the overall economy of the U.S. is a global colossus.
Gimpel pointed out that he has been interested in energy issues, so fundamental to economic health and wealth, for many years.
He directed the audience’s attention to an energy future website at nrg.caltech.edu, then select Dr. Steve Koonin. Formerly, Koonin was the chief scientist of British Petroleum Corp. On the site he gives an incisive hour and a half talk on energy that has very useful investment information.
For reference data, Gimpel directed attention to Once at the site select World Fact Book. The CIA is a peerless source of investigative information.
AAII Los Angeles County Meeting ScheduleWestside Computer Group – Don Gimpel, 310/276-9875 Sat. Feb 2, at 10:30 a.m.. Veterans of Foreign Wars Memorial Bldg. Culver Blvd. & Overland Avenue, Culver City, Topic TBA
Pasadena Group– Pasadena Library 285 E. Walnut Street,
Topic and date TBA
Mutual Fund Group – Gunter Hagen 310/457-7404, . 10:30 a.m. Sat, March 1, 2008. Topic: Smart Investing Strategies and Global Investing Trends. In the community room of the Fairview Branch of the Santa Monica Public Library, 2101 Ocean Park Blvd., Santa Monica. The meeting is free to the public
Stock Selection Group—Norm Langhout, 310/391-6430, . Fourth Wednesday of the month at 7 p.m. Fairview Branch of Santa Monica Library, 2101 Ocean Park Blvd., Santa Monica. Topic TBA
San Fernando Valley Group – Mid Valley Library Community Room, 16244 Nordhoff St. North Hills, Topic, TBA
IBD Meet-Up/AAII CANSLIM Group – Santa Monica Library, Fairview Branch, 2101 Ocean Park Blvd., Santa Monica
Los Angeles Chapter Mtg.— Up-coming meeting dates through July for 2008:, Feb. 23, March 22,, April 19, May 17,, June 28, and July 19.
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