Monday, November 17, 2008

A Best Case Economic Forecast

What am I doing saying this recession might be shallow and short? After all, I'm known as a doom and gloom kind of analyst. Does a company have a flaw it is hiding? It is my job to find it. I warned investors of the Internet stock bubble back in 1999, I even resisted my wife's plea to buy more California real estate in 2003-2005. I called oil prices a bubble in March this year (See Oil Bubble to Burst, March 11, 2008).

On the happy side, I do sometimes conclude that a particular stock may make more money than other investors think (Stocks covered by William Meyers). So I am doing this rosy economic forecast as an exercise. It is not a prediction.

It is always good to look at history before acting too certain of the trends based on current details. In American history the economy has gone back and forth between expansion and recession dozens of times. While there are non-American historic examples of total economic collapse, they are almost always due to wars, not to peaceful economic activity. So the question is not whether the nation will come out of a recession, but how deep it will be and how long it will last.

The current consensus is: deep and long.

The questions that needs to be asked are: what feeds the downward spiral, what breaks the down trend, and what starts a new upward spiral.

How did we get here? What broke the upward spiral of 2002-2006? What started us down?

It is generally accepted that the stock market was not to blame. We had a typical crisis of over production, concentrated in one sector. This was combined with a price bubble in the same sector, housing. After housing prices peaked and investors started trying to find real home owner types to unload their investments on, it became obvious to increasing numbers of potential homeowners that: 1. houses were not necessarily a good short-term investments and 2. by delaying making a purchase, they could save money.

The downward spiral of house prices corresponded with layoffs in the housing and real-estate industry. The rest of the economy was immune for a while, and if the finance crisis had not hit probably would have pulled us through without a recession. Aggravating the situation, however, was a bout of inflation, notably in the price of gasoline. This summer we saw the credit markets dry up as the bright-greedy-boys were forced to deleverage their bets. All this could have been prevented if Alan Greenspan, as Federal Reserve chair back in 2004, had paid more attention to the real economy and had spent less time kneeling in adoration at the great god Free Markets.

Now we have declining consumer spending, increasing unemployment, and a slowing world economy. The Fed is giving banks extremely-low interest rate loans but the banks are not lowering interest rates to the rest of us. Yesterday the sharks at Citibank even announced they were raising interest rates for their credit card customers.

Let me show you how to get a rosy scenario out of that.

First, Americans are saving more. Don't think of that as someone putting $100 a month into a credit union savings account at 3% interest. Think of it as millions of people who are lowering their credit card balances by $100 to $500 per month, and who are paying 20% a month in interest and fees. At our high end, after only four months a family has $2000 less in credit card debt than they would have had otherwise. Just from that $2000 in "savings" they are now going to save $400 per year in ineterest for the rest of their lives, money that would have gone to CitiGreedyCard. They have effectively given themselves a large raise.

Likewise, suppose a family realizes it now costs less to buy a home, in the long run, than to rent. Instead of buying a McMansion they buy something reasonable, a home built back in the 20th century. They start paying off their new 30 year mortgage. They build equity, remembering the lessons of 2007, and never touch that equity. Pretty soon rents have gone up, but they have that same monthly mortgage payment. Life looks good, and they have more cash to save or spend.

Throw some fuel on the fire: lower gas prices. While they are no lower than a year ago, and so won't really help, at least they are not sucking the blood out of the American consumer like they did for the past year.

The soup is looking good now. The Federal Reserve is trying to pump at least enough credit into the economy to allow people who are credit worthy to get mortgages on the homes they want. Unemployed people are milling around in large numbers, eager to find productive jobs.

As best as I can guestimate, we don't even have excess housing stock, on the whole, in the United States today. Every year many houses are lost to fire and other construction. Every year more immigrants arrive (want to solve the housing crisis in a few months? Let anyone on the immigrant waiting list who has the money to buy a house into the country immediately). The home construction industry has slowed way down lately, so as soon as mortgages can be obtained easily, the glut of new, empty housing should dry up in a few months [except in the Central Valley of California and a few other truly over-built areas].

Given all this, we could still see a thawing in the economy in time for Holiday shopping, although I would expect even a rosy scenario would have a flat period into 2009 before an actual expansion resumes.

Heck, maybe I'm not Mr. Gloom and Doom after all. Maybe I am just being realistic.

In any case, all investments (and not investing, too) carry risks, so ...

Keep diversified.

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