As promised I put together my list of market and economic predictions for the New Year.  I somewhat unfortunately managed to go 10 for 10 in last years predictions (Recap).  Admittedly my crystal ball is a bit hazier this year, and the law of averages should give people hope.  Sorry, if my predictions this year aren't any more optimistic, but I'm not going to pull a David Lereah and will just call them like I see them.

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

During 2008 we saw what was first labeled as the sub-prime crisis morph into a mortgage crisis then a credit crisis as problems spread to every type of debt security.  This year we are going to see the issues spread much deeper into the wider economy.  Job losses, particularly during the last quarter of 2008 were horrific using the reported government numbers, but downright terrifying when you factor out their number fudging.  In much the same way as government inflation numbers showed almost low inflation over the past several years when it was fairly high, there's several artifacts of the BLS's job reports that make them look much better than they really are.  Things such as the Birth/Death model and the fact that 637,000 left the job force last month because they couldn't find work (so they obviously don't count).  Using broader measures without these fudge factors, unemployment is the worst since 1983, running closer to 12% at the same time job losses are accelerating.

2. The recession gets an upgrade

Ok, I'm getting a little ahead of myself here, after all it was just officially declared we were in a recession about a month ago (backdated to last Dec) but almost everybody crunching the number on their own could have pretty much declared a recession over a year ago.  While we almost certainly won't get an official declaration this year, I think it will become apparent to independent number crunchers we will be closing in on depression territory by years end.  A depression is defined as a GDP loss of over 10%  Almost across the board economic numbers are coming in as some of the worst on record and in many cases the plunges are worse than they were in the 1930 time frame. 

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

This maybe one of the biggest stories of this last year and not next to no major press.  Simply put many of the largest public pension funds were trying to be hedge funds and were decimated.  These pension funds everybody expects to be invested in nice safe things found themselves already underfunded and decided to pile money into riskier and riskier things, CDO's, risky MBS's, huge positions in financial stocks, even the historically volatile commodity market. 

Take for example CalPERS, California's massive pension fund, they lost 103% on their residential morgage investments.  Yes, you read that right 103%, because like a hedge fund, leveraged up and used borrowed money.  CalPERS lost 25% of all assets just since July 1st ($70 Billion), and while I can't find the number to reference, I saw it calculated they lost 47% of assets in the last year.  Of course learning their lessons from Bear Sterns and Lehman Brothers, they continue to claim, nothing to see here, we're well capitalized. 

Unfortunately, CalPERS is far from alone, this same type of risk taking was par for the course among many of the large pension fund and so far the losses have been kept surprisingly quiet.  Baring the most amazing economic recovery in history, many are toast and the damage is trillions.

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

I'm basing this mainly on historical price trends in when regional real estate markets have collapsed.  The price declines typically last 5-7 years before bottoming out, but the steepest of the price declines typically occur within the first 2 years before leveling off somewhat. 

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

Back in Oct. when we hit an intermediate bottom on the equity markets, about 738 on the S&P500, I started telling people I thought there was a good chance we were about to start a multi-month rally, mainly due to the massively negative sentiment I was seeing.  As a side note it's interesting that in almost all markets, sentiment is the most negative near bottoms and most positive right at tops.  So far we've managed to rally for a month and a half and it may continue for some time, but we are far from the overall bottom.

For example during the great depression we saw more than half a dozen multi-month stock market rallies taking the market up over 40% in short periods of time, yet despite this the total loss from peak to trough was nearly 93%.  Based on many types of analysis that people have done and some of my own looking at technical patterns, historical trends and economic impacts and valuations, I think a very likely bottom could be in the 300-500 range on the S&P500 within the next couple years.  That would equate to a 68-81% loss off of the peak or 45-68% loss of where we currently are after all the nastyness in the fall. 

People subscribing the buy and hold philosophy maybe in for a shock.  The whole stock market comes back and gains 8% of year over time that people like to spout is actually predicating on picking some very "convenient" date ranges.  There's been some rather lengthy (15-20 year) periods in the last century where annual stock market returns were closer to 2% and well below that of bonds.

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

When you add up all the bailout money that's been committed to in the last several months it adds up to over $8 Trillion.  Yes, $8 Trillion, to put that in perspective the total tax revenues of the US government last year was $2.7 trillion.  While that much money has been committed to, that is not the same as actually spent or handed over, similar to social security.  Most of it is in the form of backing various debt securities, which are likely to go bad in the future.  It's basically a giant credit default swap written by the government, and we've all seen what happens to those.  So, what happens when it comes time to pay up?  Who knows?  Truthfully I don't think they have a plan, I think they're just trying to kick the can down the road a little bit longer hoping for a miracle, and a new person to be in their position.  This maybe related to the next prediction.

7. A crash in the US Treasury market?

This is probably the prediction I am feeling the haziest about, particularly since I thought we were on the verge of a crash in the treasury market late last year and instead it rallied.  But the US treasury market is beginning to look like just another giant asset bubble, and asset bubbles have a tendency to continue longer than anyone expects before collapsing.  Right now prices of long term US treasuries are the highest, thus yields the lowest they've been in, well as long I can find historical data.  This is mainly due to a flight to safety from all other asset classes, particularly other types of debt, mortgages, corporate corporate bonds, etc.

Now the problem, is this is depressing long term US treasury yields to a range of 2.5% at the same time the US is taking on a unsustainable debt load plus massive future bailout commitments (see #6).  So, either the market for US treasuries is pricing in a very, very lengthy period of deflation/depression or the market is just setting up for a spectacular crash very similar to the situation in 1931 that sends interest rates soaring.  Neither is good but given the US debt load now, a treasury crash this would bankrupt the US, giving the US two choices of either hyper-inflation or flat out defaulting on debt, both which have some terrifying consequences.  Interestingly enough, guess what's the best performing asset in hyper-inflation, yes real estate.

8. GM files for bankruptcy despite the automaker bailout

They just got billions in low cost government loans, but that isn't going to tide them over for very long.  Given how fast they are burning cash, (you couldn't burn it faster with a forklift and a blast furnace) along with a continued economic decline they'll need continuous giant cash infusions.  There's a good chance the next cash infusion this spring comes in the form of DIP (debtor in possession) financing for a pre-packaged bankruptcy.  Really, a bankruptcy is the best thing that could happen to GM as it's the only legal way it's going to be able to restructure in a way that allows for long term survival.  Chrysler is in the same boat, but Ford is in substantially better financial shape and will probably avoid bankruptcy.  If the government really wanted to help Detroit it would be better off using part of that money to supply seed funding to several new car companies but unbordened by past liabilities and being smaller and more agile could be more innovative.

9. Regional bank failures and consolidation accelerate

I was somewhat shocked to only see 25 bank failures on the FDIC's Failed Bank List at the end of the year.  Though you could realistically add several others like Wachovia that when through FDIC forced/assisted mergers.  To me not proof that the banking system is in better shape than I thought, but rather that the FDIC and OTS are even more incompetent than I thought.  There are dozens, probably more like hundreds of regional banks that appear better capitalized than they really are, due to um, creative accounting. As far as the biggest of the banks go, keep an eye on Wells Fargo, who've continued to profess they are clean, just don't look to far into their books.

Allowing them to continue to operate while realistically very under-capitalized is putting more and more depositor and tax payer money at risk.  These bank failures and mergers mean that the banking system will continue to consolidate into a few super banks, clearly including the likes of Citigroup, Bank of America, JP Morgan/Chase, etc.  The problem is these are some of the worst offenders out there, they simply get to survive because they happened to be the biggest thus are getting the direct government assistance.  Is this really good for America?  I think you know the answer to that one.

10. A revolt against corruption

The last 10 years ago has probably been some of the most corrupt years this country has seen at all levels both government and corporate.  Much of this corruption still has yet to get the exposure it rightfully deserves.  What was once frowned upon became the status quo.

Maybe this is more of a hope than a prediction, but 2009 may mark a turning point in this cycle.  Maybe it'll be a new incoming president (for the record I think both parties are equally as corrupt) or maybe the spreading economic problems will finally cause people not to be able to afford their cable bill, thus interrupt their stream of American Idol and Dancing With The Stars.  I don't know but hopefully people not only wake up but start to display the outrage needed to actually change things.