2008 Review

[Editor's note: The Update will return for 2009 on Sunday evening, January 4th for your reading pleasure on Monday morning the 5th.]

Back in January we had two posts that indicated our thoughts for the coming year. We include them here for review:

2008 Preview Part One:

In the short term we have been looking at a move to 12,500 and with the Dow sitting on 12,800 we think the Dow is ready for a break in 2008. It's been struggling to go up for several years now and it must be tired. Plus, the economy is showing signs of fatigue as well.

Housing: Our mainstay has been the housing situation. 2007 was the year that the public started to feel the pinch of lower prices and tougher credit. The ATM they live in decided to take a break. The 2007 holiday buying season may have been funded by credit cards but that routine is about to stop. The ability for people to borrow money from their houses to pay off miscellaneous debt has been challenged both in terms of the willingness of the lenders and the ability to service the debt by the borrowers. In 2008, this is going to be a big problem.

The market seems to think this way today.

Deflation: With so much emphasis being placed on the falling dollar and rising oil, we thought it was time to discuss the inflation situation. As everyone knows, the Fed chairman has been focused on providing liquidity to the bond market and he has done this in several ways in late 2007 and is continuing in early 2008. The problem is that the flight to safety in the Treasury bonds is continuing with some possible pauses on occasion. What is really going on is that the world has turned and the credit expansion is now going to turn to credit contraction giving way to deflation. During 2008 there will be some realization of this and the Fed will be powerless to prevent it despite the strong opinions to the contrary from Helicopter Ben. Our premise continues to be that the housing contraction will lead this credit contraction into deflation...We think that deflation will be a big topic for the Update in 2008 so we'll move on to the commodities.

Deflation became a big topic late in the year and continues to be a hot topic in the media. What we said a year ago was that "the Fed will be powerless to prevent [deflation]". We didn't have our thinking caps on tight enough to think about the Government opening up its wallet. This turn of events caused us to move to an inflationary stance for now. Deflation still has a chance to reappear later in 2009.

Gold: At the moment, gold is trading at or near all time highs along with oil. Some grains are trading magnificently higher. So, the central bankers have added liquidity and where has the money gone? First, it went into stocks then into real estate and now into commodities. We continue to see the central bankers, especially the Fed, trying to maintain bubbles to put off what has become an inevitable recession.

Looking at this, we didn't really make any long range forecasts here.

Recession: We are confident about a recession being announced in 2008, one that may have already started. December did not show us very good numbers at all so far and we expect more bad news. The mood of the people is one of hesitation now rather than confidence. We see this as a strong signal that the shift in sentiment is occurring. Confidence means people will buy things on credit (increasing their debt) but hesitation will cause people to consider what they are buying. The cost of gas and food and paying for that expensive house they live in will put a crimp in their expense budget for other items. We must clarify that the expensive house may be getting cheaper but in the mean time the mortgage has not changed. Living on the margin of this kind is a dangerous place to be.

Even back in January, recession seemed to be obvious. As we now know the economy was just declared in a recession, as of December 2007. The housing mess has taken up quite a bit of the media's attention. Home prices are too high and as they come down the mortgages seem to stay...

2008 Part Two

Stock market:

The stock market has shown us a high that should stay in place for a long time. In the October to early November period, all the major indexes pushed to new highs or relative new highs. Since then we have seen a pull back in all of them, well, except the HUI, our favorite gold mining index.

The highs we saw a year ago have indeed held for all of 2008. Now the question remains as to how long is "a long time"? We'll leave that question for later when we provide our forecast for 2009 and beyond.

There is one index that has another story, too.The Russell 2000 index, a leader in this market over the past several years, failed to make a new high in the October/November period. This index has dropped nearly 20% since its highs from last summer. The Russell 2000 is a small cap index, one that provides a good representation for the small investors. The stocks in this index have provided a lot of upward movement over the past several years and now they are tired out. This is a good indication that the market is headed down.

The Russell 2000, RUT, ended 2007 near 765 after being as high as 855 in June and July of 2007. This November, RUT traded down to 375 and today stands around 485. It has truly led the market (down) after failing to make new highs back in the fall of 2007 as the other indexes rallied to new highs.

Stocks have tried to ignore all of the credit problems. Part of the reason for this is that the oil stocks have proceeded much higher along with the price of oil. Here again, oil should be near its top and $100 should put a lid on it or somewhat higher prices will curb its upward move.

While we did sort of miss on the top for oil, it did top around $145 even as the media proclaimed that oil was going to $200. This week oil traded [Editor's change: This should have been "under $41".] That price represents a fairly good buying opportunity along with other commodities at the moment. These price swings are so violent that trading must be done carefully.

The news over the past few days has given some assurance to the bulls that the mortgage problems are behind us. The news from the Fed is that they are willing to lower rates in "substantive additional action". To us, this means one thing, that the Fed will lower rates at least 50 bps at their January meeting. They are not afraid of the consequences of lower rates, they are simply concerned that the market is signaling a downturn in the economy.

The Bank of America did rescue Counrtywide, or as some call it, Country Fried. The other rumor was that one more mortgage bank would be helped out. JP Morgan was rumored to be ready to step in to take over Washington Mutual.

All three of these items are part of the great effort to paper over the problem one more time. The stock market is a result of the attitudes of the many people who own stocks. The people need to be confident for the stock market to stay up, or not move down. This process has already turned down with the unemployment rate going up and the housing market not doing too well. The consumer confidence figures are low based on what is going on.

The remarks here are almost the same as they have been over the past few months. The papering over has been taken over by the government.

The market has no reason to go up in 2008. We think the top of the Dow in 2008 has already been seen. We were hoping to see a bit of a rally going into the first week of the year which is when we were hoping to make that statement. There are possible ways for the market to go up but we think the next moves by the banks or the Fed will not be very well received. The Fed will decide to lower rates several times this year but the market will not react the way they think it should.

The Fed has lowered rates several times and now Can't lower them any more. The market has failed to hold up even with this campaign of lowering rates. One thing we emphasized during the summer when everyone was clamoring that the Fed would need to Raise rates due to inflationary pressures, was that the Fed would Not raise rates.

There will be some opportunities for upside but they should be from much lower levels. We think the stock market will end the year 2008 with prices lower than where we started the year. You???

The year has not concluded just yet but it's likely that the market will end 2008 with much lower prices. And there were several rallies during the year that all led to further selling. We think a more substantial rally has started from the October/November lows that will surprise to the upside in January around the time of the inauguration.

That was then. What about 2009?

This post has taken too long so our forecast for 2009 will need to be finished in January. The important thing to remember is that the first couple of weeks in January should surprise to the upside.