10 Predictions for 2009

Insight Newsletter

Issue #29

2008 is finally over.  2008 was by all accounts, a watershed year — a year when at the end, nothing was as it had been before.  1989 was also such a year when the Berlin Wall fell (and Communism with it), as was 1981’s Reagan Revolution, and of course the fall of American Idealism through the assassinations of Martin Luther King Jr. and Bobby Kennedy in 1968.

The focus of our yearend issue is a glance at the past, then a firm eye towards the future. As we enter 2009, we are more optimistic than pessimistic.  Housing and credit issues, combined with slowing global growth, higher inflation, and rising unemployment, will make for a very tough year on investors.  However, many of the best multi-national common stocks, and their bonds, are selling at value prices.

For 2009 we are neutral on stocks, bullish on both corporate and municipal bonds, and bearish on government bonds.

2008 marked the repeal of the Credit/Finance economy.  However, the repeal is still in its infancy.  The breadth and magnitude of the dismemberment of financial institutions remains unknown.  The economic downturn starting in July 2007 affected everyone.   While few could articulate how much they actually were affected, one was left with the damning question, is this simply the normal course of the economic cycle, or did we bring the asset bubble collapse upon ourselves?  Millions of words have been penned trying to describe the collapses, from Bear Stearns and Alt-A mortgages, condominium price collapses and pyramid and ponzi schemes.  Wall Street greed, CEO greed, hedge fund fraud, is revolting.  If Hollywood wanted to show everything wrong with money and America, it couldn’t have done a better job than follow the headlines of 2008, which showcased all that is wrong with Wall Street, public companies, private companies (Madoff, Petters) and other folks in the Hedge Fund and LLC/LLP world of limited partnerships.  The Madoff Shame is such a potent reminder:  if it sounds too good to be true, it damn well probably is!

The origins of the asset bubbles and credit driven economy began 28 years ago with David Stockman’s economic plan & supply side economics.  Stockman was Reagan’s Budget Director 1981-1985.  http://en.wikipedia.org/wiki/David_Stockman.  Ultimately, the system of budget building and tax cutting pioneered by young Stockman brought us to our 10-Trillion dollar national debt (from $1 Trillion in 1981.)     Globalization charged forward in the 1990s on the basis of systemic overspending.  The system was financed by domestic and foreign lenders, and fueled by conspicuous consumption, housing appreciation and inflation.   Asset inflation abetted initially by corporate raiders, leverage buyouts, and junk debt: later by mortgage innovation, rocket scientist financial engineers, black boxes and hedge funds, created and sold their systems and products through a variety of financial companies and sales organizations (LLC’s, Investment Banks, Mortgage Banks, structured products). The dynamic of financial innovation fueled the conflagration of spending.

However, crazy it now appears in hindsight, systemic overspending was a stabile paradigm.
Government fiscal and monetary policy, from Reagan to Bush Jr, supported the existence and growth of these enabling factors.  The finance economy paradigm relied on the existence of:

  • Availability of consumer credit
  • Expanding governmental credit
  • Rising US imports
  • Creative US financial institutions with the capital and will to assume evermore liabilities
  • An ever-expanding derivatives market backed by credit-worthy counterparties.

The paradigm of this system was destroyed in 2008.  Not some, but ALL of these requirements of the existing global financial system failed or were serious eroded in 2008.  The point to no-return was reached the weekend of September 15th when the government allowed Lehman Brothers, a firm with its tentacles in every crevice of the financial maelstrom, to fail.  With that decision, the virtuous cycle of the finance economy was irreparably torn asunder.

The term “reflexive” is used in social theory to describe circular relationships between cause and effect.   Billion George Soros, a brilliant money manager whose passion was philosophy, expanded at length in “Alchemy of Finance” (1987) how Reflexivity relates to economics http://en.wikipedia.org/wiki/Reflexivity (social_theory).   To Soros, the momentum of price change actually changes the fundamentals of the participants themselves.  A weak economy can be made very healthy, if credit is cheap and easy to get (and thus causing asset values to expand), thereby increasing the leveragability and creditworthiness of the asset base.   In a nutshell, the health of the U.S. and global economies were tied to asset inflation.

Since we are now in the midst of asset deflation, does this mean financial Armageddon?  Our answer to this question is “Maybe, but probably not.”  The essence of creative destruction is the “creative” side of the process.  Free markets and free people are intelligent actors.  They can, and do respond to change.  The duration and magnitude of a vicious cycle is unknowable.  However, we do know that intelligent actors and pragmatic people find solutions faster than expected.  The surprise of 2009 could be that the system heals faster than we expect.  With no further ado, here are the 2009 predictions.

Predictions for 2009

Likely to Occur

Prediction 1:
Obama’s coattails have the Teflon strength of Reagan.  Nobody thinks it’s a good idea long-term, or intermediate term, for the government to spend an extra Trillion.  But for 5 months, the general public suspends judgment, because Barack’s just a great communicator.  And both the American, as well as and world audience, has really missed having a good communicator at the helm. Obama’s legislation all gets passed, and the vultures are held off until September 2009 when they go ballistic at the 2nd Coming of the Works Progress Administration (WPA). See #5.

Prediction 2:
After a 30-year moratorium in Nuclear Energy construction, several nuclear energy projects are approved in 2009.  Together with clean technical regulations for the approval of retrofitting coal fired power stations, a small bull market is reignited in the infrastructure and engineering companies in late 2009.

Prediction 3:
The Republican Tax Cut will be approved in February together with a massive Infrastructure Works program.  The tax cut is total ineffective at stimulating demand in the economy, but the stock market rallies 10% on the hope of the infrastructure projects and the jobs that will be created through this.

Prediction 4:
Autos follow airplanes.  Like Boeing swallowed McDonald Douglas, so will go the automobile industry.  After reporting a total of $100 billion of losses in the previous 6 quarters, the government steps in and tells GM and Ford to merge and restructure.  Chrysler’s assets are dispersed to European and auto parts creditors.

Prediction 5:
The economy ends the year in the dumpster as official unemployment flirts with 10%.  Markets take it in stride, ending up 7% on the year.

Unlikely to Occur – but it wouldn’t surprise us if . . .

Prediction 6:
Iran, Venezuela and Russia announce liquidity crisis in the face of the worldwide slump in energy export revenues.  Iranian leaders face protests in the street, Venezuela announces a series of new nationalization attempts in its effort to stopgap the fiscal disaster (Venezuela is 94% dependent on oil revenues). Russian energy companies curtail expansion as the credit crisis imposes a liquidity crisis on them while the Russian government simultaneously increases corporate taxes by 40%. These disasters in the late spring lead to a bottom in energy prices below November 2008 levels.

Prediction 7:
Obama enacts WPA II after all other efforts (tax cuts, infrastructure plan) prove too slow and ineffective to halt employment losses (which reaches 9.5% in June 2009).  Between 1935 and 1943 the WPA provided almost 8 million jobs. Anyone who needed a job could become eligible for most of its jobs.  Hourly wages were the prevailing wages in the area; the rules said workers could not work more than 30 hours a week but many projects included months in the field, with workers eating and sleeping on worksites. Before 1940, there was some training involved in teaching new skills and the project’s original legislation went forward with a strong emphasis on family, training and building people up.

The WPA built 650,000 miles of roads, 78,000 bridges, 125,000 buildings, and 875 miles of airport runways.  Only 7% of the budget was allocated to arts projects, presenting 225,000 concerts and 475,000 artworks -which was the mostly widely criticized of the New Deal agencies, but it did succeed at getting money into the hands of the unemployed. Until closed down by Congress and the war boom in 1943, the various programs of the WPA added up to the largest employment base in most states.

Obama realizes in Q4, that local, state, corporate and other entities can not get money to the people fast enough to end the recession.  The triumph of free markets over communism in 1989 is replaced the nuclear fallout of a banking crisis and the profligacy of consumption.  Just before the Christmas recess Obama pushes through WPA II, a jobs program that proposes to spend $1 trillion making new jobs that purport to put American’s back to work.  Markets sell off violently, but hold above Dow 6000 as they see this inefficient government works program as a necessary evil.  Besides, as China and Japan continue to foot the bill, who cares what it costs?

Prediction 8:
Federal Reserve mortgage buying creates a boondoggle for Wall Street banks saddled with previously dangerous mortgage paper.  The Federal Reserve balance sheet balloons from $2 Trillion (up from $1 Trillion in 2008) to $6 trillion by year’s end.  The 30 year long bond, after languishing below 3% for much of 2009, falls out of bed, declining almost 20% in 3 months to yield 4.5% in the 4th quarter of 2009 on fears of the over-leveraged U.S. balance sheet, global reflation, and improving housing situation (the decline ends), and the shimmer of economic recovery on the horizon.

Prediction 9:
The Yankees reach the World Series, but fall short against the Dodgers whose scrappy no-star team reminds Boomers and Gen-x’rs of Lasorda and Fernando Valenzuela.

Prediction 10:
Gold falls to $595 in late spring 2009 on fears that a recovery and ongoing liquidity crisis and commodity bust will never end.  Alternative asset managers and hedge funds throw up their hands and sell all of their positions in May.  Gold shares revisit 4Q08 levels.  Subsequent reflation and a flight to safety brings Gold back by year-end to close at $978, within easy striking distance of its March 2008 high.

In Conclusion
We think we have our work cut out for us this year.  It’s likely to be another very tough year on client portfolios and their managers.  We continue to manage our clients’ money in the less growth sensitive areas and we are taking advantage of the once-in-a-lifetime opportunity in precious metals, while investing in many Dow stocks paying dividends of 4% to 9%.   Barnes Capital protects client’s wealth with less portfolio risk compared to the standard asset allocations of mutual funds, brokers, and other investment representatives.

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