and the longer the market ignores the facts the larger the fall will be
I am still "bearish" on the equity markets and the actual economic health of the US economy. Just because nothing bad has happened does not reduce the risk that it will. The fact that the market has rallied does not negate the fact that it still can go down and investors can lose capital. Risk is still high and reward is based on the "greater fool" theory more than ever before.
So, I am ringing in the New Year with some Things I Think Will Happen...and again I state that just because I have written some of this before and to date it has been less than correct, does not mean it will not be correct going forward.
HIGHLIGHTS include...
1)Auto Bubble will burst
2)Higher interest rates will matter...especially to the impervious Housing market
3)Refinance activity will slow dramatically...consumers will run dry
4)Consumers will run out of money/credit
5)Metals will resume bull market and reach new highs...Gold $500+
6)Fannie Mae will blowup
7)Energy prices will reach new highs...Oil $60+
8)Apple's Ipod will become latest over-hyped gadget
9)War in Iraq will spin "totally out of control"...US troops will be hit with catastrophic casualties
10)Market indices will give back last 2 years of gains and then some...
Dow-16%(<8,900)/s&p>-18%(<971)/nasdaq-25%(<1,600)
1)The rubber will finally hit the road for the automobile manufacturers as well as automobile retailers and auto part suppliers. During a historically difficult economic growth enviroment, automobile manufacturers have "magically" induced the American public to "buy" their new vehicles at a pace which just a few years ago was thought to be impossible. The problem with the sales activity, is that many, if not most, of the sales were encouraged and facilitated through financing that left much of the risk on the sellers balance sheet. The manufacturers basically allowed consumers to take the cars for "little or no money down", in some cases with no payments for 3-6 months, and accepted very favorable financing terms (for the buyers) and extracted no collateral to do so. In addition, the manufacturers continued to produce vehicles at a pace that could not avoid creating a glut of new cars that last longer and have better warranty terms than previous production ramps ups. This has created a situation where we now have the "youngest" and potentially longest "life span" vehicles on the road than ever before. Used car values have dropped substantially, and in the next few years many consumers will own their vehicles "free and clear" and will have little or no incentive to buy a new vehicle as the value of the used vehicle will be much less than the value the vehicle provides to keep it...i.e. use as first car for child, "station car", vehicle for older parent, etc. The real "bogey man" for the automobile manufacturers may come in the form of credit defaults. During this period of peak sales, the sales have become harder and harder to come by, and the sellers have become more and more lienient with credit approvals in order to keep up the sales pace. Those 2 factors were a terrible combination for Sears a few years ago, and I forsee a similar problem for the lending arms of the major automobile manufacturers. Finally, as sales slow, the earnings from the financing divisions will drop. While the sales trends have been artificially propped up by incentives and creative financing deals the bulk of the auto manufacturers earnings over the past 3 years have come from the financing of the vehicles, to the tune of some 50-75% of profits came from the financing divisions of Ford and General Motors. Slower sales will necessitate difficult production cuts that could last for 12-24 months. The combination of production cuts, lower earnings from the financing arms, and higher credit defaults could produce a very difficult economic reality for the automobile industry.
2)Higher Interest rates will matter and will have a negative impact on many consumer areas but most significantly on the over-heated HOUSING market. The marginal buyer that was given the gift of low interest rates, easy lending enviroment, and lax appraisal process for the last 3 years will now encounter the reality that a home purchase is "the biggest and most important purchase of your life". Carry costs will become unmanageable, ARM's will adjust upwardly raising mortgage payments, and any economic difficulty or career disruption will result in a very bad problem. For new buyers, the mortgage application/approval process along with the valuation/appraisal process will become more stringent and less forgiving. Refinance activity that has helped to support homeowners with carry costs, upkeep, and home improvements will slow due to higher rates and more stable or falling home values. Homeowners will struggle to deal with higher rates on adjustable rate mortages (ARM's) and will find it difficult to extract any new cash from their homes. Low interest rates that fueled strong sales of new and existing homes will be a distant memory and further increase in home sales and prices will become harder and harder to achieve. Homebuilders that have continued to forecast unabbated sales growth and have built inventory of spec homes and acquired land for future building will find a more difficult pricing enviroment and a less than able consumer to sell to. Oh yeah...remember the one about "3 hikes and a stumble" and "don't fight the FED"... well how about "5 hikes and a wipeout" and "don't forget that stocks usually go down when rates go up"?!
3)Refinance activity will slow dramatically. This will happen due to higher interest rates and a slowdown in the appreciation of real estate values. Other factors will converge to reverse a huge increase in lending activity which occurred due in part to lower rates and in part to large increases in values of real estate over the past few years. The combination of those 2 factors along with higher demand, creative financing, easy credit process, and lax appraisal processes allowed for a huge "extraction" of capital from hard assets which was subsequently "spent" by consumers to maintain their living standards. These trends are likely to reverse, and credits will be strained. Lenders including banks, credit card companies, mortgage lenders, automobile lenders(i.e. F, GM, GE, etc.), store branded credit card lenders, furniture lenders, will all experience a decline in credit worthiness of borrowers/buyers and that will undoubtedly lead to a rise in credit defaults as well as lowers sales volume due to fewer qualified borrowers/buyers. Prime and sub-prime lenders will be hit with a "double whammy" type impact in the form of lower sales/transactions/servicing fees and higher default rates which will lead to large writeoffs. A 3rd impact will be higher expenses as they will have too many employees and overhead to handle the lower levels of business volume. Clearly the sub-prime lenders like NEW New Century Financial and NFI Novastar Financial would suffer severly from a slowdown in mortgage lending activity and an increase in default rates on loans to the somewhat less than credit worthy borrowers. Others that will experience this "pain" could include companies that have benefitted greatly from the mortgage refinance boom of the last few years including HRB H & R Block, F Ford, GM, General Motors, GE General Electric, some homebuilders, especially those catering to 1st time buyers...including CTX Centex, LEN Lennar, RYL Ryland Group, & BZH Beazer Homes, and any other large company that arranged for "seller financing" type deals with consumers in order to help facilitate demand for their products that without financing would not have been there.
4)The US consumer will finally run out of money/credit and retail sales will slow significantly. Consumer retail darlings will suffer sales declines and will be forced to close rather than open new store locations. Clothing, furniture, auto, electronic, jewelry, and home improvement companies will all experience this slowdown. ANF Abercrombie & Finch, BBY BestBuy, CC Circuit City, RSH RadioShack, FD Fedeated Department Stores, SKS Saks, KSS Kohl's, MIK Michael Stores, HD Home Depot, AEOS American Eagle Outfitters, ARO Aeropostle, PSUN Pacific Sunwear, ZLC Zales, TIF Tiffany, AN AutoNation, KMX CarMax, HDI Harley Davidson, POOL SC Pool, PII Polaris Industries, FBN Furniture Brands, ETH Ethan Allen, HVT Haverty Furniture, etc, etc. Any retailer that relies on easy credit and/or a frivolous consumer will face challenges in 2005. Beneficiaries would include TGT Target, WMT WalMart, COST CostCo, DELL Dell Computer, ROST Ross Stores, BBBY Bed bath & Beyond, and others that provide consumers with selection of necessary daily items and a value proposition for discretionary purchases.
5)GOLD ($500)and other metals such as silver, platinum, copper, aluminum, etc. will reach new highs as the US$ continues to erode and demand from China continues. The US$ will reach 1.43EURO and will break 1.00yen. Implications are hard to predict, yet it seems pretty clear that foriegners may limit or stop investing in $US priced asstes and may limit or stop lending money to the US Government, thus hurting spending and causing rates to rise...possibly dramatically. Metals' price increase will hurt manufacturing of various products and cause renewed interest in storing capital in "hard assets" such as Gold and Silver. Any type of serious geopolitical "upset", i.e. major terrorist attack, would also cause a surge in the price of Gold.
6)Fannie Mae will falter and create a significant credit crisis for the mortgage market. The SEC, Justice Department, NYSE, and governmental scrutiny will all prove to be "too little too late" for equity shareholders and for some bond holders, as shortfalls in capital and internal controls will be uncovered, revealed, and will pose a meaningful systematic risk for the overall market. My guess is that the newly placed CEO and management of the company will blame the highly computerized qualification process, new computerized credit scoring systems and approval processes, and lack of internal controls at lower levels for the foul ups. Outgoing CEO Raines will plead "not guilty" to anything he will be charged with and will lay blame on his underlings for not doing their jobs properly. The Federal government will in some way "come to the rescue" of this "too big to fail" entity, for the greater good, but the shareholders equity will be greatly diminished &/or wipped out in the process. short FNM.
7)Energy prices will resume the uptrend and will reach new highs at the levels that many analysts and economists say will create an OIL CRISIS ($84). I think there is a 50/50 chance of a supply disruption caused by terrorism, natural disaster, or OPEC "problems", which would not only cause prices to rise dramatically, but would cause other problems for the economy as well. Many industries that rely on Oil or energy to make their products will suffer margin compression as costs rise and competition will pressure selling prices.
8)The Ipod will prove to be the latest example of a great idea/gadget that "flashes" in the pan. Even as the "gift of the year" this past holiday season, I believe that competition and new product offerings will prove too much for the Ipod to handle. Sales of the popular and colorful MP3 player will flag and will not create new interest in the Apple computer hardware or Macintosh operating system. Recent history is full of what I call "cool but worthless" products. The most recent example is the Palm Pilot, which continues to be a great product and very useful, yet once it was mass produced by every electronic manufacturer and the prices fell while inventories increased, the future profitability disappeared. Another "cool but useless" gadget is the picture phone, which is fun and cool for the first month the consumer has it, but thereafter is just a novelty that is rarely used by the cell phone customer and will not provide a premium price for the cell phone manufacturers to add into phones...i.e it will be given away to induce additional sales and to be competitive. The Ipod is the latest example of a glorified gadget. It is no more than a "fancy" MP3 player that does way too much, holds way too much, and costs way too much. Many formidable competitors have entered the fray to sell MP3 gadgets to the insatiable American consumer, and the result will likely be a similar demise in prices and profitability as the Palm Pilot and picture phone suffered, as well as a decline in Ipod demand. Short AAPL.
9)The War in Iraq, being sold to the American public as an important front on the War on Terror will spin totally out of control. The Coalition forces, aka US Troops, will endure more casualties and deaths than in the previous years. I predict that American troops will be hit with a "catastrophic" attack resulting in the loss of hundreds of soldiers. (I do not wish for this to occur and I loathe the thought, but I do think it is a real possibility.) An attack similar to the Beirut Barracks Bombing that was the beginning of the US exit from Lebennon. If this does happen, the American public will revolt against the war in Iraq, and the President and his administration will be foced to withdraw troops and turn over Iraq to Iraqi control. I also think that there is a 50/50 chance of a terror attack in the US which would result in a renewed sense of fear in the general public and a lack of confidence in the governments efforts to protect the US from terror, despite all the money spent and the efforts put forth to do so.
10)The above confluence of events will result in a very bad trading environment for US equities and will create an enviroment where investors will continuously be disappointed with geopolitical events. Bad news will dominate the headlines and news crawls. Business and economic news will suffer. Business leaders will retrench again and will resist hiring new workers and will cut back on capital spending until a more stable world is evidence. This will result in lower equity prices and I think the major indexes will give back all of the gains of the last 2 years.
Dow-16%(<8,900)/s&p> -18%(<971)/nasdaq-25%(<1,600)
I continue to beleive that we are in a longterm period of economic decline. I see the last few years, since 2000, and the next few years, till say 2008-2010, as the 2nd Great Depression for the majority of the US population...especially the rapidily growing middle and lower class. The upper class wealthy American people have been helped famously by the Federal Government and lopsided pay models of Corporate America. As with most things, financial well-being and economic prosperity are "relative" and relative to past economic periods, the current state of our economy and the future economic outlook is at best "relatively" dismal. The media is fortunate in that it can focus on the positive and "pretty" things up so that the masses don't get to worried or upset. The media helps most to believe that "good times" are upon us or that its only a matter of time before it will be. The reality is much less sanguine and as the baby boom generation heads for a very difficult and protracted period of retirement and old age. Economic malaise will be what most boomers experience. Unfortunately for the baby boomers, the government and the next generation; their children and grand children, are totally unprepared, and unwilling to take care of them, and they are in no way prepared to take care of themselves. As the "greatest generation" lives longer than any of its ancestors, the economic reality of huge healthcare costs, lack of employment opportunity, lack of savings, and high costs of living will create a very difficult period of time for this huge swath of the population during their "golden years".
Stephen Roach, the well known global strategist, economist, and resident Bear at Morgan Stanley recently wrote a piece regarding the risks that abound in the equity markets. Here is a link to check it out for yourselves. Ignore this at your own risk.
No comments:
Post a Comment