Things Are More Fragile Than They Look

09/08/2010 12:00 pm EST

Focus: MARKETS

Curtis Hesler

Editor, Professional Timing Service

Curtis Hesler, editor of Professional Timing Service, says declining demand, along with problems in commercial real estate and rising energy prices, could strangle the recovery.

Here is my take on the inflation/deflation issue. Those things that you don’t have any choice about buying and absolutely must pay for (i.e., food, medicine, insurance, taxes) are going to continue to get more expensive.

It was recently reported that widely used brand-name prescription drug prices rose 8.3% in 2009 versus an “official” year-over-year [consumer price index] increase of 2.7%. You should expect more of the same in the years to come.

On the other hand, discretionary items will find demand woefully thin. For example, restaurants that offer a relative bargain—especially for a family—will find they are flooded with customers at the expense of more costly restaurants.

Folks, the recession and the evolution of declining consumer demand for discretionary items is going to last a long time—at least another decade.

The real estate market is in step with this problem of declining demand. In fact, real estate is at the root of the problem in some ways. Residential real estate will find a bottom below where the market is currently and then stay at that level for five to ten years.

There is [also] a tsunami coming in commercial real estate. Prior to 2008, there was some $5 billion in commercial loans that were in actual default. That level remained reasonably constant year over year—until recently. The amount of commercial loans in actual default is now about $120 billion, and that is accelerating each month.

I [also] see crude prices going much higher—and likely very soon. This will increase all energy prices, which will put severe pressure on an already failing economic recovery. The Federal Reserve will continue to fight perceived deflation, while the citizenry will get clobbered by higher prices for necessities.

The truth is, recession aside, crude prices have held up. Prices did correct in line with our outlook this spring and summer; but as we progress toward year end, crude prices are staged to advance toward the $90 [a barrel] level.

Longer term, crude will best the old highs at $145 [a] barrel set in 2008. That is certain. Just how much higher is uncertain, but I would not be surprised at $200-plus. The deep water drilling in the Gulf [of Mexico] will resume; and, as I have mentioned, similar drilling is currently in progress in other parts of the world. One thing is known—[the oil companies] are not taking these enormous risks to produce $80 oil. The big kids see something much more expensive in the future.

A near-term bounce aside, you should expect the market will be lower by the end of September, with further weakness in October. The October decline will be savage and will accelerate from weakness expected later this month. There is a swoon coming, and you need to be ready for it.

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