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Why I’ve Turned Bearish
12/04/2008 2:51 pm EST
The headline says it all: I've turned bearish on stocks.
I wasn't struck by lightning. I didn't have an epiphany. Just the steady drip, drip, drip of bad news has turned me from my longstanding optimistic view on US markets to a much more sober outlook for the next several years, an evolution that readers of this column may have observed over recent months.
We're in a global recession that has gathered momentum over the last couple of months and will likely get worse. The financial crisis will suck up resources for months, maybe years. Consumers are retrenching big time in the US, and that has cut global growth. And government involvement in markets has increased dramatically and is likely to get even bigger.
It all suggests several years of underperformance for stocks, punctuated by bear market rallies, but I don't see anything in the economy that will drive global equity markets back to their all-time highs of last October until well into the next decade.
That probably will require some adjustments in your investment strategy, which I'll get into next week, along with some analysis of sentiment and market valuations.
But first, let's look at the grim economic picture.
The National Bureau of Economic Research (NBER) has just officially declared that we've been in a recession since December 2007.
But lately we've seen a cascade of bad economic news (both here and abroad, as in the UK) that suggests the economy is in a downward spiral, with no bottom in sight.
Gross domestic product growth actually went negative in the third quarter, layoffs are rising, jobless claims have averaged over 500,000 for the most recent four-week period, and unemployment stood at 6.5% before Friday's monthly report.
But more critically, consumer spending has just fallen out of bed.
Forget about initial reports of good sales increases on Black Friday and Cyber Monday—much of that was due to opportunistic bargain hunters. Consumers are likely to be much more tight-fisted in the three weeks before the holidays, resulting in a dismal selling season. And what will drive sales in 2009?
As for durable goods, just witness the desperate groveling by chief executives of the Big Three US auto makers before Congress for a piece of the bailout pie as auto sales—not just for them, but for everybody—have plummeted.
Stephen Roach of Morgan Stanley, writing in the Financial Times, points out that real personal consumption expenditures may tumble by 3.5% in the second half of 2008. "Never before has there been such extraordinary capitulation by the American consumer," he writes.
That's not surprising, given the financial crisis and the massive deleveraging that's burning through the economy like a wildfire in Malibu Canyon. Analyst Meredith Whitney of Oppenheimer & Co., who was correctly bearish on financial stocks early on, estimates that "more than $3 trillion of available credit has been expunged from the markets and therefore corporate and consumer borrowers so far this year." That money, she says, "has gone to plug holes and not stabilize the effects of shrinking liquidity."
It's no surprise, then, that she concludes: "I am more bearish today than I have been in the past 18 months."
The problem is that after a year of trying everything and committing trillions of dollars to a massive rescue of the financial system, central bankers and heads of state still don't know if their proposed solutions will work.
Exhibit A: Treasury Secretary Henry M. Paulson, Jr., who can't seem to decide whether the $700-billion Trouble Assets Relief Plan (TARP) should be used to shore up banks' capital, buy actual toxic assets, or help struggling homeowners refinance their mortgages. Not exactly a confidence-inspiring performance. Maybe the new Obama Administration will at least be able to get its story straight.
But I don't know if it can do a lot more than that. With estimates of bad debt on the books of financial institutions running into the trillions, it's unclear whether all the governments in the world have enough money to fill this gigantic hole—even if they kept the printing presses rolling from now until the 2010 Super Bowl.
And while we're on the subject of the government: Will the prospect of $1-trillion annual US deficits; some increases in top marginal tax rates and maybe dividend and capital gains taxes, and tighter regulation and greater government involvement in the economy really inspire investors to step up and buy stocks?
You've got to believe that's highly unlikely, no matter whom you voted for.
So, where does that leave us? I contacted A. Gary Shilling, the veteran economist and editor of INSIGHT, who has been as prescient on this crisis as media superstar Nouriel Roubini.
Shilling predicted the housing bust years ago; said last year that the economy would enter recession in late 2007, and has advocated shorting stocks and buying long-dated US Treasury bonds. Bingo on all counts. (Here is a list of 13 recommendations he made in early 2008.)
When I spoke to him this week, he sounded vindicated but hardly cheerful. He still expects the recession to last until the end of 2009, unless the financial problems are even worse than they appear—in which case it could extend "into 2010 and beyond."
He looks for GDP to drop by 5% annually early next year and for unemployment to peak at 8% or so. All in all, he expects this to be "the most severe recession in the post-World War II era."
And he thinks housing prices aren't close to a bottom. The S&P/Case-Shiller Home Price index is down 21% from its 2006 peak. But with at least 1.6 million unsold homes still sitting on the market from the bubble, Shilling thinks prices can fall by another 20% nationwide. "We're about halfway through," he says—and he looks for the housing bust to end by the fourth quarter of 2010. Ouch!
But most importantly, Shilling says we're just beginning the long, painful deleveraging of the American consumer, who as we all know went on a decades-long, debt-financed buying binge, driving household debt to 117% of personal income and knocking the official savings rate into negative territory.
As credit dries up and consumers have no choice but to rebuild their battered household balance sheets, Shilling looks for the savings rate to rise by one percentage point a year for the next decade until it reaches about 10%, where it stood in the early 1980s.
The New Frugality, he believes, will depress consumer spending, the engine of the US and much of the world's economy, now at 70% of GDP. It, and other effects of the crisis, could cause GDP growth to drop to 2% a year from the 3% average—a dramatic decline.
So, that's the grim economic backdrop I see for the markets in the years ahead. But isn't it a little late in the game to be turning bearish, after stocks are down more than 40%? Could my "surrender" be part of the capitulation that signals a market bottom? And how should investors position their portfolios for the months or years ahead?
I'll try to answer those questions next week.
Howard R. Gold is executive editor of MoneyShow.com. The opinions expressed here are his own and are not necessarily the views of InterShow or MoneyShow.com.
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