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BCA’s "Outlook" For 2008 & Beyond |
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FORECASTS & TRENDS E-LETTER IN THIS ISSUE: 1. The “Long-Wave Upturn” Is Not Over Yet 2. On The Economy & The Odds Of A Recession 3. BCA On Stocks, Bonds, The Dollar & Energy 4. What Could Go Wrong With BCA’s Forecasts 5. 2010-2011: Recession & The End Of The Long-Wave Upturn 6. Conclusions & What To Do Now Introduction If you have read this E-Letter for long, you are well aware of my considerable respect for The Bank Credit Analyst. Despite the expensive price tag, I have been a continuous subscriber to BCA for over 30 years. Of all the many forecasting services I have tried over the years, BCA has been by far the most accurate in predicting trends in the economy, inflation, interest rates, the dollar and the major investment markets. My favorite monthly BCA issue is their “Outlook” for the New Year, which comes out each year in the last days of December. BCA’s Outlook 2008 is particularly insightful in that Martin Barnes and his fellow editors not only provide specific forecasts for 2008, but also do some analytical peering into 2009, 2010 and 2011. That’s a span of four years, which is unusual for BCA, and I think their outlook will surprise you. As I usually do at this time of year, I will summarize BCA’s latest forecasts for you in the pages that follow. Given that BCA’s latest outlook extends for several years, we have a lot to cover in a limited amount of space, so let’s get started. [Editor’s Note: For the benefit of our newer readers, you can check out The Bank Credit Analyst at www.bcaresearch.com or you may call BCA at 800-724-2942 (in US) or 514-499-9706 (for readers outside the US). BCA’s headquarters are located in Montreal, Canada.] Brief History On BCA’s Major Forecasts In order to put this discussion into perspective, a little background is in order. Back in 1982, when the US was embroiled in the last serious recession, BCA made what was to most readers a rather shocking long-term forecast for the US economy and the major investment markets. At a time when many were forecasting gloom-and-doom and a financial crisis, BCA predicted in 1982 that the US economy was about to begin a long-range period of surprising economic growth and an unprecedented bull market in financial assets (ie – stocks and bonds). BCA called this period the “Long-Wave Upturn” and characterized it as a multi-year phase where: 1) US economic growth would continually surprise on the upside; 2) recessions would be few and mild; and 3) financial assets would enjoy tremendous growth and profits. This surprising forecast was based primarily on BCA’s belief that the Technology Revolution would change the world economy, and the US was (and still is) the global leader in technology. I must say that BCA’s Long-Wave forecast in 1982 was considered balderdash by many in the investment world at the time, and even I had my doubts. But I drank the Kool-Aid despite my misgivings and shared BCA’s long-term forecast with my clients. Sure enough, BCA was proven accurate in spades. Since the last serious recession in 1981-82, the technology-led US economy has continually surprised on the upside. We have seen only two recessions (1990/91 and 2001) in the last 25 years, and both were quite mild by historical comparison. Meanwhile, the US equity markets have enjoyed the greatest bull market in history over the last 25 years. US bonds have enjoyed a similar bull market as interest rates have plummeted from their lofty levels back in 1982. The “Long-Wave Upturn” Is Not Over Yet Fast-forward to today. The US economy is clearly slowing down following a period of red-hot growth. We have a major housing slump, serious credit market problems, a weak US dollar, and numerous respected analysts are predicting a recession in 2008 and beyond. Even BCA admits that the odds for a recession in 2008 have increased in light of the housing slump (more on this below). Yet BCA continues to believe that a recession in 2008 is not the most likely scenario. Rather, they see a year of slow growth in 2008, with GDP averaging around 2% or a little less, with no recession, and a potentially strong economic rebound in 2009. In short, Martin Barnes and his fellow editors at BCA believe the Long-Wave Upturn they predicted back in 1982 is not over yet, and that it has at least a couple more years to run. They believe the next serious recession does not likely unfold until around 2010-2011. Along this line, BCA projects that while US stocks will likely be jittery in the first half of 2008, they will be higher by year-end and again in 2009. They continue to believe that emerging market stocks, generally speaking, will likely outperform US stocks in 2008. BCA also predicts that the US dollar will bottom against the major world currencies in 2008, although it will continue to fall relative to most emerging market currencies. Obviously, this forecast is contrary to the current widespread bearish sentiment on the dollar. BCA readily admits that the risks to their latest forecasts have definitely increased in light of the housing slump and credit market problems. And they also realize that in order for their forecast for 2008 and beyond to be correct, the Fed has to accelerate its efforts to lower interest rates and re-liquefy the credit markets. BCA also admits that its latest long-range forecast is based on their continued projections that inflation is not going to get out of control over the next year, and in fact will begin to trend lower. It is on this very point that most bearish analysts take issue with BCA. Most analysts are convinced that inflation will continue to head higher (ie – oil over $100), but BCA disagrees. The above is the “Cliff Notes” version of BCA’s latest forecasts for 2008 and well beyond. My guess is that most readers are at least somewhat surprised at BCA’s rather benign outlook for the next couple of years. Frankly, I have some questions of my own – specifically regarding how we avoid a recession until 2010-2011. I have my doubts, but it has rarely paid to second-guess BCA. Now let’s get into more of the details of BCA’s latest forecast for 2008 and beyond. On The Economy & The Odds Of A Recession As noted above, the BCA editors believe the odds of a recession in 2008 have increased, largely due to the housing slump and the credit crunch, but they maintain that a recession is not the most likely scenario. BCA’s economic models project that the odds of a recession in 2008 are around 40% at best, with a 60% chance we will not see a recession this year. Obviously, there is no shortage of analysts and writers who disagree and are convinced we will have a recession this year. Some even claim that we are already in a recession, but that is not the case. A recession is generally defined as two (or more) consecutive quarters of negative growth in GDP. For us to be in a recession now would mean that GDP growth – which was a whopping 4.9% in the 3Q and 3.8% in the 2Q – went negative in the 4Q, and that it will be negative in the 1Q as well. 4Q GDP numbers are not out yet, but growth last quarter is generally expected to have been in the 1-2% range, so we are not in a recession yet, despite what you may read elsewhere. In addition to being correct about inflation remaining under control, BCA points out two other key elements to their 2008 economic forecast. First, as discussed above, the Fed has to move aggressively to re-liquefy the credit markets, with more rate cuts and more liquidity injections to the system. That remains to be seen. The next FOMC meeting will be held on January 29/30, at which time we should see another cut in the Fed Funds rate if BCA is correct. The other key element to BCA’s forecast is a continued strong labor market in the US. The US unemployment rate unexpectedly rose to 5% in December, the highest level in two years. However, it is important to keep in mind that a 5% unemployment rate is still very low, and most of the jobs that were lost in the last half of 2007 were in housing and construction according to the Labor Department. Jobs growth in the services sectors continues to rise, giving BCA confidence that the labor market will remain generally firm, despite the overall economic slowdown in 2008. BCA says:
So, if BCA is correct, we will see much slower growth in the economy in 2008 than in the last couple of years – likely averaging 2% or less in GDP – but a recession should be avoided if the Fed keeps its eye on the ball and the labor markets remain relatively strong. BCA’s Outlook For Stocks & Bonds In 2008 BCA has been bullish on stocks for the last several years, although they did advise subscribers to reduce positions and take some profits in November due to the credit market problems. The editors now believe that the US equity markets are likely to churn in a generally sideways pattern over the next several months until concerns about the credit markets subside. Once that happens, they believe equity prices could have another strong upleg beginning late this year. I have been thinking for the last several months that the US equity markets are now primarily driven by what the Fed does, or does not do, in relation to the credit markets. Simply put, if the Fed continues to cut interest rates, then I think stocks will hold steady or move higher. However, if the Fed becomes stubborn and makes it clear they will not lower rates further, then that has serious negative implications as discussed above – not the least of which is a recession. If the economy rebounds in 2009, as BCA expects, then we could see possibly the last upleg of this long bull market. If BCA’s outlook proves correct (or mostly correct), the next upwave in stocks could be quite strong. BCA continues to favor emerging markets over US equities, even though most emerging markets have risen powerfully over the last couple of years. As for US stocks, BCA favors those companies and sectors that have strong global presences over companies that only operate domestically. BCA even believes there will be an opportunity to go back into stocks of the large US money center banks sometime in 2008 if their outlook proves to be correct, although they are not making such a recommendation at this time. As for bonds, BCA believes there is limited opportunity in US government bonds in 2008 as yields are already very low. As for high quality corporate bonds, the editors believe there is an opportunity for profit over the next six months or so, but beyond that BCA does not like the risk/reward in corporate bonds. They do feel that foreign bonds could have another meaningful downleg in yields this year as the US economy slows down and takes most of the major global economies with it. The bond markets seem to me to be more of a “traders market” than a trending market, and most investors are not well suited for such an environment. Later on, I will remind you of a professionally managed long and short bond program I recommend for sophisticated investors. BCA’s Outlook For The U.S. Dollar Most market analysts around the world are very bearish on the US dollar, yet BCA is changing its view on the greenback. BCA has never agreed with the perma-bears that have predicted a freefall in the dollar leading to a major currency crisis. In fact, in their Outlook 2008, the BCA editors predict that the US dollar will bottom out against the major foreign currencies, while at the same time continue to fall against most emerging market currencies over the course of this year. What this means is that BCA expects the dollar to begin to hold its own against major foreign currencies such as the Euro, the Pound, Canadian dollar, Australian dollar and the Yen, while at the same time continuing to fall against emerging market currencies such as those in Asia and South America, generally speaking. The editors say:
If BCA is correct, it should not come as a surprise if there are some powerful short-covering rallies in the dollar in 2008, what with bearish consensus at such a high level. This suggests that if you are holding unusually large short positions in the dollar, you might want to consider taking some profits in the weeks and months just ahead. BCA’s Outlook For Energy & Resource Prices While BCA concentrates its analysis on the financial markets (stocks, bonds and currencies), the editors have been consistently bullish on energy prices for the last several years. Regarding oil, for example, the editors have suggested for over a year that prices would surprise on the upside, and indeed they have. Even with the major spike up in oil prices over the last year, with crude topping $100 per barrel last week, we have not seen a meaningful decline in the global demand for oil and gasoline. While it is true that there has been a marginal decrease in oil consumption in the G-7 developed nations, demand from emerging markets (including China and India) continues to rise. With the economic slowdown in the US in 2008, and the resultant slowdown in the global economy, demand for oil should decline over the next year, which should keep a lid on prices generally speaking. But BCA is careful to point out that the economic slowdown is likely only temporary, and when the global economies rebound in 2009, energy prices are likely to move to even higher plateaus. So, they remain bullish on energy over the long-term. What Could Go Wrong With BCA’s Forecast? Before we move on to BCA’s longer-range forecasts for 2009-2011, let’s take a brief detour and discuss some things that could render the editors’ projections for 2008 incorrect. First on that list has to be the housing slump and continued problems in the credit markets. The inventory of new and existing houses on the market continues to rise. While housing starts have fallen dramatically, they will have to fall more in 2008 for the inventory of unsold homes to peak and turn lower. This means more bad news for homebuilders. Home prices will continue to fall in 2008. The only question is by how much. Most of the estimates I see are in the 15-20-25% range over the next 12-18 months, as a national average; some areas will be even harder hit, while a few areas like Austin, where I live, are still holding up very well. Home foreclosures continue to rise as more and more homeowners are bailing. The number of vacant properties is reportedly at a record high. This trend surely has further to run as well. An estimated $500 billion in mortgages (or more according to some sources) face interest rate resets in 2008. The continued housing slump could put a larger damper on consumer spending than BCA currently forecasts. And what about the credit markets? Everything I read points to more bad news in the subprime market in 2008. Likewise, it is still not known just how large the major banks exposure is to collateralized debt obligations (CDOs), but it is believed to be huge. Major banks and mortgage companies continue to write off massive chunks of bad debt, and most will have to find ways to raise capital this year. We are definitely not out of the woods on the credit crunch, and this is another reason why BCA’s forecast for 2008 may be too optimistic. BCA Maintains That Inflation Is Not A Big Problem If one is looking for more reasons to disagree with BCA’s latest Outlook 2008, the next place to start would be with the editors’ forecast for US inflation. For most of us, we see inflation soaring all around us. Oil prices topped $100 per barrel last week. Gold surged to a new all-time high above $850 per ounce. The US dollar is at the lowest level in many years. Grain prices have skyrocketed, largely due to the ethanol myth (expect a future E-Letter on this), so food prices are soaring around the world. The headline Consumer Price Index jumped an unexpected 0.8% in November, and was up 4.3% over the last 12 months. But like the Fed, BCA believes it is best to focus on “core” inflation, which excludes the prices of food and energy. Core CPI was up only 0.3% in November, and was up only 2.3% over the last 12 months. BCA believes the core rate of inflation will decline over the next year and even longer. The editors believe that the overall inflation rate in the US will be more influenced by falling home prices and the slowdown in the economy than by rising food and energy prices. They may have a point here as the housing slump is clearly far from over, and the economy is definitely slowing down. It is obvious from recent Federal Reserve policy statements that the Fed Open Market Committee (FOMC) remains obsessed with inflation concerns, even though they have cut interest rates at the last several FOMC meetings in response to the housing slump and credit crunch. But BCA believes that the Fed needs to cut rates much further in 2008 in order to head-off a recession. BCA predicts the Fed will cut short-term rates from the current 4¼% to 3% in 2008 as inflation concerns diminish and the housing/credit problems play out. Martin Barnes and his fellow editors readily admit that if they are wrong on their inflation forecast, they will probably be wrong on most of their other major predictions as well. But the editors are confident that inflation will surprise on the downside this year as the economy slows down and the housing slump continues to unfold. 2010-2011: Recession & The End Of The Long-Wave Upturn? So what does BCA foresee beyond 2008? As discussed above, BCA believes the US economy dodges a recession in 2008 and then manages a potentially strong recovery in 2009. If the economy does rebound strongly in 2009, the editors believe that inflation could quickly become a problem again, especially in the second half of the year. If the Fed cuts interest rates remotely as low as BCA expects this year, then the FOMC would quickly begin to ratchet up rates at the first signs of renewed inflation in 2009. With each successive economic cycle, the overall debt numbers get higher and higher, and the Fed’s monetary reactions also tend to get larger and larger in both directions. Thus, the BCA editors believe it could well be that in late 2009 or early 2010 the Fed raises rates to such a point that it throws the US economy into a recession in 2010-2011. BCA says:
Very interesting! Two specific questions arise for me, assuming the scenario above is reasonably correct: 1) Does the Long-Wave Upturn come to an end with the next recession; and 2) Might the next recession be a really severe one? As you may recall from my December 4 E-Letter, I traded e-mails with Martin Barnes in late November just after BCA openly called on the Fed to cut rates aggressively to deal with the credit crunch. At that time, I asked Martin if he believed that the Long-Wave Upturn was about to come to an end. He responded that the editors still believed the Upturn had another few years to run, barring any major negative surprises. In BCA’s latest Outlook 2008, Martin Barnes and his fellow editors do not specifically address the Long-Wave Upturn or when it might come to an end. But after 30 years of poring over their monthly reports religiously, I think I’m quite good at reading between the lines, even if they don’t say certain things directly. I surmise that the BCA editors now believe the Long-Wave Upturn could come to an end with the recession they foresee most likely in 2010-2011, and that recession could be a very severe one. I could be wrong, of course, but I doubt it. When we consider what the debt will be at virtually all levels in 3-4 years, a recession could be devastating. When we consider the number of Baby Boomers that will be retiring in 3-4 years, the strains on the already insolvent Medicare system will be enormous. Social Security will likewise be struggling. I don’t want to risk being categorized as a gloom-and-doomer, and neither does BCA, but we could be looking at a very serious situation when the next recession unfolds. Conclusions & Long-Term Implications BCA’s forecasting models continue to indicate that a recession in 2008 is not the most likely scenario. Instead, their outlook is for slow growth averaging 2% or less this year. But BCA does not believe the Long-Wave Upturn is over just yet, and they expect a rebound in the economy in late 2008 or in 2009, perhaps a strong recovery, which could propel stocks to yet another – and possibly final – powerful upsurge. If the economy rebounds meaningfully in 2009, inflation could rebound strongly as well, which would compel the Fed to raise interest rates again, perhaps aggressively in late 2009. These actions by the Fed could well set the stage for the next recession in 2010-2011. The next recession could spell the end of the Long-Wave Upturn BCA predicted back in 1982. Obviously, the US economy is headed into a slowdown in the near-term, and it is impossible to know for certain if a recession awaits us this year, or if it will be in 2010-2011 as BCA suggests. The housing slump and the credit crunch are far from over, and it is impossible to tell just how bad things may get over the next 12-18 months. One thing is clear: risks to the economic outlook continue to rise, and risks in the markets continue to mount. Buy-and-hold investment strategies that do not include risk management could get hammered in the next 2-3 years or longer if BCA’s Long-Wave Upturn finally comes to an end. My advice to readers is that you make a concerted effort to seek out investment strategies that are designed to protect your wealth over the next several years, as opposed to taking on more risk in the hopes of maximizing returns. What To Do Now In my opinion, investors need to be looking for defensive, risk-managed strategies for a significant portion of their portfolios this year, in preparation for what may follow in the next several years in the economy and the markets. If you have been reading this E-Letter for long, you know that my company, Halbert Wealth Management, has specialized in searching for professional equity and bond money managers that seek to deliver risk-managed returns for the last 13 years. In light of the outlook for the bond market, in particular, I would suggest you re-read my October 2, 2007 E-Letter when I introduced you to Hg Capital Advisors, a firm that offers a long/short Treasury bond strategy that may be very effective for sophisticated investors who maintain allocations to bonds. You should check out Hg Capital Advisors, especially given their performance in 2007, by visiting my website at www.halbertwealth.com. We also offer carefully selected mutual fund portfolios that are designed to deliver “absolute returns” in both rising and falling market environments. Plus, we can also provide customized investment management for clients in need of such services. If you haven’t taken a look at the investment programs my company offers, perhaps now is the time to do so. It doesn’t matter where you live. We have clients in all 50 states, most of whom I have never met. In the Internet age, you shouldn’t limit yourself to dealing only with local investment advisors, financial planners or brokers. In light of BCA’s latest analysis for the next 3-4 years, and the possible end to the Long-Wave Upturn, maybe now is the time to become one of my clients and invest some money into one or more of the risk-managed programs I recommend. Finally, you don’t have to be super-rich to be one of my clients – we have professionally managed programs that require only $15,000-$50,000 to invest. And remember, it doesn’t matter where you live in the US. I invite you to call us at 800-348-3601, or click on the following link for our online information request form. Happy New Year,
Gary D. Halbert SPECIAL ARTICLES:
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