Mid-Year Update - 2009 Market and Economic Predictions

We are now officially half way through the year so it's time for me to do an update to my 2009 market and economic predictions, also known as, Matt is being a buzz-kill again.  The quick scorecard is, four have already occured, four I'm still predicting will happen, one I still think will occur but probably not this year and one is DOA.

The media has become fairly delirious from smoking few too many of those "green shoots" as of late along with 90% of economists calling for the recession to end shortly.  It should be noted that a similar number of economists were confident we'd avoid a recession in the first place. They are latching onto month to month fluctuations in data claiming the economic recovery is upon us, while almost all trending and forward looking data is continuing to paint a fairly pessimistic outlook. 

Another main factor in my continued pessimistic outlook is the attempt by those in charge to play confidence games instead of solving problems.  If we believe things are getting better, they will, right?  Confidence without the foundation to support it, it not a very good economic base to build from.

1. The "Credit Crisis" morphs into much wider economic crisis

Ok, I think this one is playing out as we've moved from people claiming we're just having financial system and housing issues to seeing dramatic drops in employment and even more dramatic drops in tax revenues (corporate, income, sales).  While the official government reported unemployment rate is now up to 9.6% the broader unemployment measure like U6 has now skyrocketed to 16.4% the highest since the 70's. 

The data shows job losses are actually accelerating, not decelerating.  With the unbelievably dramatic drops across the board in tax revenues, we are just beginning very extensive layoffs from the nations largest employer, the local, state and federal governments.  We also have not seen the layoffs happening in the automotive industry show up in the official numbers yet.

2. The recession gets an upgrade

While I didn't expect an official pronouncement this year my prediction is that we'd meet the criteria for a depression not just a recession, which is defined my more than a 10% total loss in GDP.  I still think this is going to happen, and in fact I think the forward looking data makes this almost a lock to happen.  Though, this quarters GDP coming in flat or even just slightly positive wouldn't surprise me.

For some great visuals on how bad the economic trends really are check out this post on Nate's Economic Blog.

http://economicedge.blogspot.com/2009/04/economic-cliff-diving-by-charts.html

3. Pension funds, the biggest non-story of 2008 becomes THE STORY of 2009

Ok, I'll give myself about 1/3 of a point for this one.  The story is huge, it's just getting almost no play in the main stream media.  Many of the largest pension funds in the country are in deep trouble shifting into riskier and riskier investment strategies to make up shortfalls.  For example CALPERS the largest pension fund in the country shifting large portions of their assets to real estate right at the top of the bubble and then stocks right at the top.  They are in a massive hole, and have stated they are relying on being able to borrow from the state of California to fill the massive hole.  Yes, the state who tomorrow will start issuing IOU's in lieu of checks to pay bills.

Not to be outdone by California, PBGC (Pension Benefit Guaranty Corporation) which insures pension funds including those at GM and Chrysler followed suit.  Why are the pension funds pursuing such a risky strategy that would once have been looked upon as insanity? 

He said the previous strategy of relying mostly on bonds would never garner enough money to eliminate the agency's deficit. "The prior policy virtually guaranteed that some day a multibillion-dollar bailout would be required from Congress,"  Boston Globe article on PBGC

As they say, when in a hole, keep digging, or something like that...

4. House prices continue to fall, but in most regions not as fast

Not much to add here, the Case-Schiller data showed a 19% year over year price drop first quarter, with declines in all 20 major markets they track.  Anecdotal the declines in many markets appear to be slowing but historically in housing downturns the steepest declines occur in the first 2 years, where the average overall length of price declines in 5-7 years.  There's also still a huge backlog of foreclosures sitting on bank balance sheets which have been held back from the market.  This will keep inventories in most markets elevated for some time and keep the downward pressure on prices.

Update: Just saw the updated Case Schiller data released today, basically shows what I expected.  Still declining across the board but at a much slower pace.

5. The stock market is far from seeing a long term bottom

My prediction was that we'd see the November lows of 738 on the S&P500 broken this year, and we saw that happen in the first quarter of this year ominously putting in a low at 666 on the S&P 500.  Despite a several month, 35% straight up rally since then I don't believe we've seen the lows for this bear market, and see a high probability of the S&P500 going under 500 later this year.  Simply put we are still in a deleveraging phase and we've seen a massive drop in corporate profits making the stock market extremely overvalued at it's current level by almost all metrics.  These profits by and large were driven by the credit bubble, particularly in financials and unless we are able to blow another massive bubble they are not returning, like some are placing bets on.

 

6. Where does the bailout money come from when it's time to pay up?

We'll have to see, they just started issuing the debt a couple weeks ago, and we're now issuing as much treasury debt per week as we were per year less than a decade ago.  This is at the same time the major foreign buyers are slowly inching their way to the door, buying shorter and shorter duration debt, as the FED tries to hold back the flames through quantitative easing.

7. A crash in the US Treasury market?

This was the prediction I said I was the most hazy on last year, and now I think it's inevitable due to the insane government spending we've seen coupled with the gigantic collapse in tax revenue.  The FED has been pulling every trick in the book trying to surpress rates and support the treasury market through quantative easing.  History shows these types of efforts are simply fingers in the proverbial dike that inevitably bursts.  If the treasury market does crash you'll see double digit interest rates on mortgages within a few months.

On a related note, the consensus of late seems to be for rising interest rates but due to (hyper)inflation.  I simply don't see the case, all of the data points to massive deflation.  Oh, the FED's monetizing debt and printing.  The problem is the deflationary pressures and wealth destruction is dozens of times larger.  Also, the FED pumping money is only inflationary if the money moves, as inflation really is the velocity of money not the size of the money supply.  A small amount of money moving very fast through an economy is more inflationary than a large amount of money that sits on a banks balance sheet plugging holes.  The fact it's being used to plug holes that are not magically going away, is exactly why I don't see it suddenly becoming inflationary.

8. GM files for bankruptcy despite the automaker bailout

My prediction was that both GM and Chrysler would file for Chapter 11 bankruptcy this year despite their bailout at the end of 2008 with the goverment providing massive DIP (debtor in possession financing).  Check...

9. Regional bank failures and consolidation accelerate

We're up about 50 regional bank failures this year compared to 25 all of last year.  Technically I guess this counts as acceleration but it's still well below the hundreds I was expecting.  It has nothing to do the increased stability in the banking system and more to do with the FDIC and OTS not doing their job to protect depositors and tax payers. 

A good example of this is Bank United a large regional bank in Florida that collapsed about two months ago, at an estimated cost of about $10 Billion.  This bank was on my list of dead men walking back in April of 2007, due to the how badly their loan portfolio had already depreciated.  Two years ago it was clear from their balance sheet without pulling accounting tricks they were insolvent.  Every Friday for nearly two years I was shocked when I didn't see an announcement his bank had been seized due to how far gone it was.  Had it been seized two years ago it's likely there would have been very little, if any cost to the FDIC and US taxpayers, instead it cost us $10 billion. 

Then two weeks ago the head of the OTS resigned after it turned out he had ordered the Bank United to falsify financial statements to cover up their insolvency.  Yes, the top banking regulator was ordering banks to fudge their financials so they would appear solvent and would not be seized.  Bank United is not an isolated case, not by a long shot.  In fact, 2 other high ups at the OTS resigned or were fired in the last year for pulling similar stunts with other banks.  There is a organized effort to avoid failures at all costs by covering up the problems and hoping they go away.  This just makes the ultimate failure many times worse.  

The government banking "stress tests" meant to prove to the public and investors how sound are banking system was a similar sham.  We're already well past the loan default rates used in their most stressful scenarios, banks were asked to provide the valuations for complex securities like CDO's, and provided values many times above current market prices.  Commercial real estate, who's impact on bank balance sheets is likely to be worse than residential mortgages, showed almost no losses in the stress test numbers.  

Suffice to say, I expect the next "unexpected" banking crisis to rear it's head this fall at the latest and this time I'm not sure if there's the will political will to throw a few hundred billion more at it.

10. A revolt against corruption

Grrrrrrrr...  Where's that change Mr. Obama...  Must stop writing here or I'll launch into a rant and this post will be 20 pages before I know it...