Denninger's Predictions for 2009 - Happy New Year!

[Lucille]

Where We Are, Where We're Heading (2009)

Ok, so with that cheery backdrop, here you go with my predictions for 2009.... and I will prefix this by saying this is a list I hope proves to be entirely incorrect. Perhaps there really is a Unicorn that craps skittles even though I've yet to find it - this is one round of predictions I'm willing to take a zero score on come December 09.

* The economy will not recover in 2009. Job loss will continue through the year and unemployment will reach 8% in the "headline" statistic by the end of the year. U-6 (broad unemployment, or the closest to "real" unemployment without government "cooking") will top 15%. All the "talking heads" are predicting a turnaround in the second half of 2009. They will be wrong. Look at their records for 2008 - all of them were predicting closes at or above 1500 for the S&P 500. Why does CNBC continue to put people on the air who, if you listened to them, cost you 40% or more of your money?

* Deflation, not inflation, will become evident well beyond housing. Other capital goods beyond housing will see real price declines for the first time since the 1930s. Debt is inherently deflationary; the "hyperinflationists" will once again be shown to be wrong (how many years running will it be now?)

* Housing prices will continue to decline. I believe we're about halfway done with the price correction. Those who think we will turn this in 2009 are wrong - unless we get an all-on collapse in prices in early 2009, which I do not believe will occur. I've heard several claims we will have positive year-over-year home price changes in 2009. I'll take the other side of that bet.

* The Fed's attempt to "pump liquidity" will be shown to be an abject failure. We will see either a Treasury Market selloff or worse, severe instability in the dollar at some point in 2009.

* GDP will post a 12-month negative number and there is a decent shot that we will actually see an official depression print before the end of 2009, defined as a 10% decline peak-to-trough.

* The Stock Market has not bottomed although you may think it has for a few months. The annual range will be quite extreme; I would not be surprised at all to see 1,000 touched on the SPX in the first part of the year. I believe the SPX will at least touch 500 in the next 12-24 months and the current bottom will not hold. It is possible that we could see a crash to SPX 300 and DOW 3,000 some time this year, probably after the spring (when the "Obama Halo" wears off - if it isn't blown off by economic events first.) Yes, this means I am predicting a fifty percent swing in the SPX in 2009. Lots of money to be made as a trader if you're quick and good, but an absolute minefield if you're a long-term investor.

* Precious metals will not be a safe haven. The callers for $1600 and above on gold will be wrong, unless there is a major military conflict. I do not rate that probability as particularly high, but it is an event (along with a major terrorism incident - nuclear or biochemical - that would cause a rocket shot in Gold prices), so I am hedging that call. The risk of this sort of "response" to the economic crisis is, however, real, and will rise significantly going into 2010 and beyond. We'll revisit this one (a major war) next year.

* The Dollar will not collapse. This is not because we're in great shape or will truly recover, it is because the rest of the world is in worse shape than we are. Last year pundits were all calling for the dollar to collapse to 40 - it didn't happen. Now they're calling the dollar's strength a "Bear market rally." Nonsense; the simple truth is that while we're in bad shape the rest of the world is literally on the precipice of a full-on collapse. European banks are more-levered and less-transparent than our banks as just one example.

* The pound or euro - and perhaps both - will likely be where the FX dislocation initiates if it occurs. I see the potential for the pound and euro to both reach par with the dollar, although I'm not going to go that far out on the tree limb and predict it - yet. Needless to say that would rocket the Dollar Index but it won't be our strength that does it - it will be their weakness.

* The US Consumer will go from a negative savings rate to a seriously-positive one. I am predicting 4% in 2009 but it could go as high as 10%. The math on this is simple - the "consumerist legion of more" has run its course and all that's left is debt. It hurts and bad; expecting the American Consumer to cut off his other arm is just plain dumb. By the way this is a good thing in the longer term for America once the excess debt is forced out and defaulted through the system.

* Commercial Real Estate will effectively collapse and most commercial Real Estate REITs will be either insolvent or limping on life support. There will be calls for bailouts (which may be attempted; the calls are already starting to be heard) but it won't matter - a failed business is a failed business, bailout or no, and overcapacity must go away before sustainable business conditions can return.

* Along with the above, expect 10% of all retail stores to close, and that number could go as high as 20%. That's not going to be fun; there will be hundreds of malls that wind up literally shuttered across America. Stay away from most retailers and property groups as investments. Firms like SPG and VNO are levitating on the strength of their dividends (7-10% yields at present); I believe this is a sucker play; if retailer defaults force dividend cuts (and I believe they will) the commercial REITs will go straight into the toilet.

* Several states will get in serious financial trouble and outright default of one or more is possible in 2009. California leads this parade. But even if there is a default on a state basis, the effect will be highly localized, as county and municipal governments vary in their wisdom and budget process. The real pain comes in state-wide social and educational programs. Be very careful if you are in municipal bonds or thinking of getting back into them (I recommended they be dumped in 2007 - look at what has happened to the closed-end funds in 08! Aieeee!) as the default risk is VERY REAL. If you're buying individual issues and do the work to determine not only the risk of default but also the likely recovery if they do default there are some good deals out there - but only if you're doing the work. "Trust me" (as in buying funds, whether mutual funds or closed-end stuff) is very dangerous.

* Mortgages are not done. The story last year was "Subprime." This year's will be "ALT-A", "Option ARMs" and so-called "Prime". The Fed and Treasury know this, which is why they are playing games with "agency" debt in a desperate attempt to clear this market before the ticking nuclear devices go off. The amount of debt involved in these "bad deals" is vastly higher than that in the "subprime" space and if they fail to contain it (a near certainty) Round #2 of severe bank instability gets served up on us in the second half of 2009.

* If you want to refinance a mortgage you may get one brief shot at it with long rates around 4%. You're nuts to buy outright unless you intend to die in the home, but if you have a solid reason to be obtaining a mortgage or wish to refinance you will probably get the opportunity. This assumes the "buydown game" gets going before Treasuries dislocate; if you get the opportunity take it as it is likely to be fleeting. The few places in this country where homes wind up selling for 2.5x incomes (on average) and you have an opportunity to finance at 4% and change will be decent buying opportunities - if you're sure you can cash flow the note (e.g. your job and/or income stream is not in any danger of collapsing.)

* Those who have said that the corporate bond market is being "unreasonable" in its expectation for defaults will start to look like the jackasses they are. Actual default rates (not projections) on non-investment-grade debt will skyrocket starting in 2009 and there will be no sign of it turning around this year. If you're playing in this area of the market thinking that "the worst is behind us", I hope you like walking around bald as the haircuts handed out to folks like you will be especially severe and delivered with a straight razor.

* The calls for "more lending" to consumers and businesses will go exactly nowhere. The problem isn't credit availability - there's plenty of money available to lend if you are credit-worthy. Those who are being turned down now simply aren't credit-worthy when one looks at what they want to do with the money and what they're backing their repayment capacity with. The more "credit stimulus" is thrown into the economy (and there will be more) the worse the downturn will get.

* General Motors and Chrysler will fail to meet their targets and it will be labor that sinks the deal. At least one and probably both will wind up in some form of bankruptcy in 2009. The UAW is insane; Gettlefinger needs to be strung up by his genitals and pelted with rotten tomatoes by his union "brothers", and if they had a lick of sense they'd have already done it. They obviously don't. I give this mess six months tops, with Ford as the only possible survivor. The recent GMAC games show exactly how desperate they are; 0% 5 year loans to people with 620 FICO scores are flat-out insane and the default rates on those loans are going to wind up in economics textbooks five years hence.

* Protectionism and currency manipulation will rear their ugly heads in 2009, originating not here but in Asia as their economies go straight into the toilet. China and Japan are at severe risk here.

* Commodities will appear to be headed for a new bull market but this will turn out to be a false hope as demand continues to collapse. Attempts to manage oil output to prop up the price will fail. Several oil-producing nations will find themselves in serious economic trouble, with Russia being in the lead but by no means alone.

* Sovereign debt defaults will number at least three with many other nations on "watch" for same; we had one last year (Iceland.) Noise about a US "AAA" downgrade will continue. Highest on the list for probables are Russia, which needs oil at roughly double its current price - and stable - to be financially viable. Not going to happen in the near term.

* China will have its first large-scale rumbling of civil unrest as a consequence of collapsing export demand and thus employment. They'll manage to tamp it down - this year. Don't take a bet on that holding together longer-term. Those who think China will be "ok" are deluded; they have a horrifying overcapacity problem (debt-financed, of course) and there is no way for them to get out of it. They are truly going to "take it in both holes" down the road, but the worst of it won't be in 2009 - that is still a year or two in the future.

* Foreign uptake of Treasuries will be choked off - by necessity. It won't be because they want to screw the US (although they should have a long time ago, given our profligate and unsustainable habits), it will be because they will be forced to redirect their resources inward as their own economies collapse.

* "The City" (London to be precise, Britain generally) will be recognized as getting it "worse than we are" (in America.) This will be the first of many validations of my thesis "we're screwed, they're gang-raped."

* Things will get "revolting" in a number of nations. Not here in America. Yet. If we're lucky the American Sheep will wake up and stage some of that peaceful protest stuff I outlined above. If we're not so fortunate 2010 could be really bad.

In terms of recommendations its simple - rallies are to be sold, cash is to be raised and prudence is to be practiced in your own personal financial affairs. Don't get creative in all things finance, get stingy and prudent. Your personal financial survival could well depend on it.

[raystone]

I'll go along with every prediction except China crashing... the economic evidence suggests it China WILL be ok.

http://www.chinaeconomicreview.com/c...hort_term.html


(FREE) China's economic problems are short term
HOME > PAST ISSUE > PERSPECTIVE [Premium content]
December 2008

Andy Rothman

China continues to slow, and the macro news will remain unflinchingly grim for several months. We are swamped by negative data points - manufacturing output, power generation growth and export orders are all down - but there is no reason to panic. The economy has entered what will be the worst part of the downturn, with GDP growth slowing to 8.5% in the fourth quarter, and then as low as 7% in the first three months of 2009. But by the second quarter of next year conditions will stabilize and then improve, putting full-year growth at 8%-plus.

There are many reasons why China won't follow the US and Europe into an economic abyss.

Confidence
. There has not been a loss of confidence in the Chinese financial system, and there is no risk of bank insolvency. All banks are backed by the Communist Party, which is stable, liquid and pragmatic. Most historical non-performing loans were removed from bank balance sheets, leaving them far stronger than during the Asian crisis. China also holds nearly US$2 trillion in foreign exchange reserves.

Liquidity
. In China, there is only a credit crunch when the political leadership wants one. Chinese banks will lend when directed by the party, which appoints all senior bankers. Lending rose by 17.6% in September, up from 12% in January (on a quarter-on-quarter basis), and this will climb further following the central bank's removal of lending quotas. Money supply growth indicates a high level of liquidity.

External debt.
China's external debt is relatively low. Along with a fairly closed capital account, this has helped insulate the country from much of the Western financial meltdown. China's debt service ratio was just under 2% at the start of the year, the foreign debt ratio was under 30% and the ratio of short-term foreign debt to foreign exchange reserves was 14%.

Exports
. China's exports are holding up well, growing by 23.1% year-on-year in the third quarter, compared with 26.2% the same period last year. For the first nine months of this year, nominal export growth was 22.3%, down from 27.1% in the same period last year and 30.6% in 2006. The two largest export categories - machinery and electronics, which accounted for 58% of total exports last year - are slowing but remain very healthy. Most of the export growth slowdown has come from steel and garments. While falling demand in the US, Europe and Asia will knock more off of Chinese exports next year, overall growth should stay above 10% year-on-year. Net exports - the part of trade that contributes to GDP growth - have suffered more sharply: net export growth was 13% in the first nine months, compared with 51% for the same period last year. However, the overall impact of this is quite limited, as last year net exports accounted for only 16% of nominal GDP growth. When we worry about China's overall economic growth, we should be worrying about domestic consumption and investment, not exports.

Consumption
. Private consumption remains very strong. Retail sales rose 23.2% in September, just missing July's 23.3%, which was the fastest pace in nine years. Consumer spending should slow in 2009, as real urban income growth has slowed this year, but private consumption should continue to be a strong driver of overall economic growth. (Remember that Chinese households have very high savings rates and almost no debt.) Real retail sales growth should not fall below 10% next year, from the current year-to-date pace of 14%.

Investment
. Next year, fixed-asset investment (FAI) is likely to grow faster than the 25% year-on-year average of the past several years, which will compensate for some of the export slowdown. Investment growth in residential housing has dropped since June but overall new construction investment is on an upward trajectory. Land transfers are included in Chinese investment data so the increase in new construction includes the purchase and preparation of land, as well as actual construction activity. As such, an increase in construction investment in July would not necessarily translate into an increase in building rates until several months later. Meanwhile, central government spending on infrastructure was up 38% through August, compared with 16% last year - the largest fiscal stimulus program already under way, but one that has received little attention.

Producer prices and profits
. Another reason to be optimistic about next year is that falling commodity and energy prices will result in rising industrial profits. Input price pressure continued to abate in September, as the purchasing price index (PPI) for industrial raw materials and fuel fell to 114 in September, down from the July peak of 115.4. Given the trends in global commodity prices, the PPI will continue to come down, which should lead to a gradual recovery in margins and profit growth in 2009. And while industrial profit growth has slowed from last year's lofty heights, it hasn't disappeared. Ex-energy sector industrial profits grew by 27.6% in the first eight months of this year, down from 38.4% through the first five months of the year, but not far off the full-year 2006 pace of 33.6%.

Real estate
. Policy changes announced in October - a combination of lower interest rates, lower down-payments and lower transaction fees - represent a winding down of last year's efforts to artificially depressing residential real estate sales in China. Having achieved its goal of cooling price growth, taking it from 25% year-on-year last fall to about zero today, the last thing Beijing wants to do now is crash the property market. With affordability good, household debt almost non-existent, and banks ready to lend (they are all controlled by the party), home buyers will respond by returning to the market. This will result in a significant pick-up in sales activity by mid-2009, which will in turn be followed by a rebound in prices across the country (except in Guangdong, which faces serious structural problems). A good time to look at residential developer stocks.

Potential to stimulate
. Early last month, the government announced the first stage of a massive stimulus program designed to put a floor under the economy at 8% next year. Having run a budget surplus last year, as well as through the first eight months of this year, there is no doubt Beijing has the means to fund a stimulus for at least four quarters without worrying about a longer-term fiscal problem. China also needs a lot more infrastructure. The rail system is inadequate to move goods and people; many of the 600,000 villages lack a good road to the nearest market town; 300 million Chinese lack access to clean drinking water; and power generating capacity has risen rapidly without a commensurate investment in transmission and distribution capacity. A lot of infrastructure plans in the pipeline mean that spending can be accelerated at a rapid pace.

A long menu of administrative measures is also available to Beijing, including tax cuts, higher export rebates, interest rate cuts, as well as temporarily reduced enforcement of environmental and labor laws. None of these measures would promote healthy long-term growth, but they could be deployed on a temporary basis to prevent the economy from slowing below 8% next year.

[jvockrodt]

He calls for dollar instability and no inflation. How can we have dollar instability without inflation? What does this look like?

[raiha]

Markedly different from Schiff's predictions... one thing for sure it will be one helluva year.

[Epic]

not really. they probably just differ in the areas of precious metals, and (relatedly) the time that deflation will switch over to inflation.

Schiff's obviously an austrian, and i'm not familiar with this other guy, but he seems like an austrian too.

Oh yeah, Schiff has some crazy decoupling theories about how China and the rest of the world will do OK while the US burns... that actually is a big difference. Schiff's definitely in the minority view there.

[Epic]

He calls for dollar instability and no inflation. How can we have dollar instability without inflation? What does this look like?

Easy. Inflation = supply of money and credit. This will likely decrease as debt is liquidated, even as money is printed. Hence, no inflation.

Dollar instability = volatility in exchange rate of dollar, when compared to other currencies and metals... etc. Think of the dollar like the stock in a country (as opposed to normal stock in a corporation). In volatile times for the U.S., there will be a wide divergence in possible outcomes, hence large swings in the price of the stock of the U.S. (dollar). Remember the sharp market drops a couple months back? When things get panicky, things get volatile.