My 2008 Economic Predictions...!

Our Central Bank, Government, and Major Financial Institutions have the power to manipulate markets on a large scale.  They have abused this power extensively.  At some point the power of the markets will overwhelm them.  I anticipate that will happen before the end of 2010. 

Most short term predictions must take a "back seat" to the whims of the noted market movers.  My 2008 predictions would mirror nearly all of the 2007 predictions below.  The important "prediction" is the recognition that we are now in a cyclical bear market which began the end of October 2007, and should last 3-5 years.  Keep your power dry...!

My 2007 Economic Predictions…!  (posted 1-9-2007)

2006 surprised me.  I am shocked that some major trading partner somewhere has not dumped their dollars and dollar-based assets to pop the international dollar valuation bubble.  We have witnessed more “trial balloons” out of Asia and the Middle East threatening “diversification away from the dollar” than any opening celebration of the Olympics.  Yes, ALL trading partners are well aware of the horrific consequences, so they are ALL reluctant so far to make that step.  However, if there was ever an indirect way for a middle East country or Russia to inflict massive pain on the West, that would do it…!  It would massively disrupt their own markets, but it seems past patterns of logic suggest one might sacrifice his own well being as long as the enemy is destroyed.

I would also be shocked, if our own government or central bank was not directly or indirectly purchasing US stock futures, and long-term bonds via covert hedge fund (or similar) operations to prevent a levitated market from collapsing.  I believe they have given themselves permission because we are “at war”.  If they have done this on a significant scale, then discovery of this clandestine manipulation effort will not only destroy the markets, but also severely erode the dwindling credibility remaining in our government leadership, and US financial and market institutions.

The Real Estate, Bond, and Stock bubbles are just getting worse and worse.  The magnitude of the aggregate overvaluation is breaking the all-time record of the Republic last year!  See the updated “US Economic Health Graphs” here… http://www.austrianenginomics.com/id10.html  to offer a historical perspective.

I expect the Dow Jones Industrial Average (DJIA) will end up lower at 2007 year-end than it closed (12,463) on 12-31-2006.  Further, the probability of the long overdue correction is much higher as each month passes.  Again, I expect a 30% drop in the DJIA bottoming in the late part of the unfavorable season (Sept-Oct, 2007).

This prediction flies against 99% of all mainstream economist’s predictions.  It also flies against the cyclical pattern of the 3^rd presidential year being historically the strongest of all four years. 

Finally, I still recognize we are in a secular bear market that began in 2000 and will continue through the 2015-20 time frame.  I expect the DJIA to bounce between 5,000 and 15,000 for that period notwithstanding a hyperinflation reaction to a depression I expect to begin in 2008-2010.

What are the reasons for expecting a 30% drop this year before the traditional 2007 year-end rally?  Here they are:

1.      Inflation is increasing, and the FED is still "behind the eight ball".  I.e. Inflation has been rising faster than that reported by our US Government (1.8% CPI-W for the past 12 months).  John Williams www.shadowstats.com calculates the real inflation rate has been trending over 6.0% during the past 12 months, which exceeds either the short- (Fed Funds target @ 5.25%) or long-term (10-Yr Treasury @ 4.67%) rates.  Therefore, assuming John’s numbers are more accurate, monetary policy remains expansive rather than restrictive!

2.      The FED was on a rate-raising cycle that ended June 29^th, 2006.  Virtually all rate-raising cycles end up in a market semi-bust 3-12 months later.

3.      Un UNSUSTAINABLE trade deficit.  Foreign purchases of our bonds enable this most abhorrent condition.  At some point they will slow or stop, then long-term interest rates will rise significantly with severe consequences.

4.      A deteriorating federal budget deficit.  As the economy runs out of gas this year it will have a very negative effect on corporate profits and government tax receipts.

5.      A negative U.S. saving rate.  Correction of this means less consumer spending, which negatively impacts profits.

6.   An administration that is doing almost anything to antagonize our trading partners (Middle East countries, China, Japan, India, etc.).  This also lays the groundwork for war in the future.

7.      An oil and natural gas price shock....  The impact was mitigated last year by yet another Central Bank flood of liquidity, which only makes the eventual correction worse.

8.      A vulnerable presidency.  Loss of confidence in leadership can exacerbate rather than mitigate a crisis.

9.      A new FED chief; most are historically "tested" early in their terms.  The broadly held opinion of Dr. Ben Bernanke’s monetary prescription to a crisis is to promote rapid monetary expansion, which will frighten the bond markets at the first opportunity.

10.  Our housing bubble has enabled the "housing ATM" machine.  Equity extraction totaled a record $1078.2 billion in 2005.  2006 will end up approx. half of 2005’s record.  2007 should reduce further at year-end towards a reasonable historical 0.5% of GDP or approx. $60 billion.  However, as we enter the expected depression in the 2008-10 time frame the extraction will reverse when homeowners either default or desperately attempt to pay down their overwhelming debts. 

11.  The greatest aggregate bubble (real estate, bonds, and stocks) in the history of the Republic, which creates a fundamentally strong bias to revert to the mean.

12.  The carry trade "gravy train" must come to an end soon.  Borrowing in a low interest-rate country (Japan @ 0.4%) then buying U.S. securities yielding near 5% offers an irresistible arbitrage.  The incentive to make this lucrative play will continue as long as Japan (predominantly) continues to sterilize the dollar and dollar securities to keep the Yen from appreciating vs the dollar, which keeps their export market strong.  Soon Japanese Boomers wanting to retire will be asking their government and central bank why they are sitting on so much U.S. “paper”.  The massive trade imbalances will only end painfully and abruptly when the Japanese citizens realize the only redemption they can expect is yet more inflated dollars.  The FED has enabled this game, and it will end with massive derivative crashes soon.

13.  Asians buying our Treasury bonds due to our "twin deficits" have slowed significantly in the past two years.  Per the U.S. Treasury, in yrs. 2003 & 4 their net purchases totaled approx. $500 billion.  From Jan ’05 through Oct. ’06 they only purchased approx. $100 billion net.  So… Who is picking up the slack??  Largely, the "mysterious hedge funds" in London and the oil exporting countries.  The UK increased $113.3 billion and oil exporters increased $30.8 billion during the same period (Jan ’05 – Oct ’06).  I cannot imagine yet another year of mysterious bond purchasers most of whom are playing the carry-trade spread between our U.S. bonds vs. the Euro and Asian bonds w/ lower rates...  This game must end too as the dollar weakens...  When foreign interest in the purchase of our Treasuries ebbs, interest rates and inflation will increase.  Soon, the global race to competitive currency devaluation will kick into full speed...

14.  The war; its cost, leadership, and political tolls...

15.  The hurricane clean up and rebuilding costs....

16.  The yield curve inverted in September 2006, and is currently such today.  In the past 30 years each time that has happened (with one minor exception) a recession and/or significant market downturn followed....

17.  The voter’s message to government last November was more a rejection of incumbent policies and behavior, rather than support for alternate policy suggestions.  One of my greatest concerns regarding Democratic control of both the House and Senate is the increased pressure to legislate trade protectionist measures.  Our trading partners are very frustrated that the U.S. seems quick to blame them for all of the imbalance woes.  Protectionist measures would only further stretch their thinning patience, and turn them toward a dollar rejection, which could be catastrophic.

18.  Private Equity is now the latest bubble.  The value of private equity-backed buyouts this year doubled to $602.4 billion from last year, according to Dealogic, on 1,912 deals.  These deals represent a triple-whammy bubble-blowing machine.  First, they further expand the outstanding Credit Market Debt because they are debt financed. Second, they provide added liquidity “fodder” used to bid up equity prices generally.  Third, it reduces the number of outstanding shares, which enables the gross liquidity expansions to push gross stock market prices even higher (more liquidity chasing fewer stock assets).

The positives for an up market throughout the unfavorable season (May thru Oct) in 2007??

1. The Central Bank with its new leader, Dr. Ben Bernanke, and the U.S. Government will continue pulling all the stops as they traditionally have to keep the bubbles inflated because they are very popular to form and increase in size.
2. They have established a 12+ year precedent of utilizing the liquidity-flooding technique to address any economic softening or international monetary crisis.  It would be foolish to bet they would utilize any other approach.
3. The perception is that the FED has some “breathing room” to reduce the Federal Funds Target rates (currently @ 5.25%), if they encounter economic headwinds.  Unfortunately, real interest rates are still very “accommodative” (negative on short and long term).  Reducing rates now would clearly force the “the inflation genie out of the bottle” and further exacerbate imbalances.
4. Most prominent economists are forecasting a continuation of low long-term bond interest rates...  i.e. maintain the status quo.  Inherent within this logic is the continuation of the “mercantilist model” employed by the Asian countries, which artificially suppresses their currency valuations to maintain a viable expanding export market to the consumption-happy Americans.  Yes, this is what the Asian GOVERNMENTS want to pursue.  However, governments of any persuasion will do anything to stay in power.  What most economists overlook is the anticipated behavior of the Asian citizens and investors.  Soon, there will be millions of Asians retiring as their Boomers mature.  At that point they will “knock on the door” of their governments asking why they are sitting on hundreds of billions in U.S. dollar and Treasury reserves.  The fundamental question will be how do they collect on these “riches”???  They won’t…!  Soon afterwards, the citizens and investors will pressure governments to dump the extremely overvalued dollars and dollar assets regardless of the consequences.
5. If we’ve been successful at blowing ever-larger bubbles (approx. $3 trillion per year average since 1995), then why can we not continue for yet another year??  Just keep cashing the direct marketing checks we receive in the mail, refinancing to pull cash out of our homes, and buying furniture, Plasma TV’s, etc. for “0” down, “0” interest, and “0” payments through the next year or two….!  We still have a year or two before the creditors betting on us will ask for something back…!
6. The irrepressible American pride and competitive resolve..!    The entrepreneurial and productivity improvement efforts (when not suffocated by government) can yield a significant 1.0 to 2.5% real improvement annually in an industrialized country.  In today’s dollars that represents approx. $200 billion in real improvements.  Unfortunately, this pales in comparison to the asset bubbles discussed above.  i.e. the discovery of the $31 trillion “gorilla” stock, bond, and real estate overvaluation illusion will swamp the $200 billion-improvement spirit until we’re back into a reasonable economic balance.

Other than that, we should have a good year....!

Suggestions:

From the late April until mid-Novermer this year (the “unfavorable” market season of the year) get out of “non-defensive” equities and go safely to cash.

Visit the web sites on the “My Favorite Links” page.  They are aware of the risks and all have suggestions for investment and protection.