Friday, 30 January 2009

Credit Contraction Continues

Data released by the RBA today showed that credit conditions continue to tighten in Australia. Private sector credit contracted in December by -0.3%, that is the first month on month contraction in private sector credit since Dec 1992. Year over year private sector credit rose 6.7%, the lowest year over year rise since April 1994.

The RBA attributed most of the contraction to a decline in business credit. That does not bode well for the Australian economy in 2009. My opinion continues to be that the Australian economy probably fell into recession sometime in Q4 of 2008 and we are only just getting warmed up.

Whilst the Rudd government makes forlorn attempts to prop up an over-leveraged household sector and the RBA talks up the prospects of the Australian economy with rose-coloured glasses on, the economy continues to deteriorate.

Serious changes are afoot with respect to the availability of credit and the willingness to lend. Businesses that have traditionally relied on foreign sources of credit will find it tough to roll when it becomes due. The idea that Australia will somehow avoid this fate is wishful thinking yet there seems to be a fair dose of denial still going around.

Expect the RBA to cut the cash rate to historical lows in 2009 as the spectre of deflation and a contracting economy become the focus of attention.

Wednesday, 28 January 2009

US Home Prices Continue to Fall in November

US Home Prices continued to fall through November 2008 according to the latest Case- Shiller Home Price index report. The 10 city index is now down -26.6% from its peak whilst the 20 city index is down -25.1%.

There are moves afoot to try and put a floor under US housing the whinging about putting a floor under housing prices but since they have only reverted back to early 2004 levelsis it really needed? Don;t they just need to market to adjust itself? From the report:

“The freefall in residential real estate continued through November 2008,” says David M. Blitzer, Chairman of the Index Committee at Standard & Poor’s. “Since August 2006, the 10-City and 20-City Composites have declined every month – a total of 28 consecutive months. Every region was down in excess of 1% for the November/October period, with eight of the regions recording record monthly declines. Phoenix and Las Vegas were the worst performers for the month at -3.4% and -3.3%,respectively, and also have the lowest returns over the one-year period, returning -32.9% and -31.6% respectively. Overall, more than half of the metro areas had record annual declines.”

Prices will continue to come down and that will persist through most of 2008 despite what the US government does. Some of the worst affected areas could possibly see price declines of -50% or more before the worst is over.

Saturday, 24 January 2009

Bye Bye Babcock & Brown Shareholders

With Babcock and Brown's announcement Friday morning, shareholders have effectively been wiped out. Here is the money quote from the announcement:

Consistent with the announcement on 7 January 2009 regarding the Company’s negative net asset position at 31 December 2008, the Board believes that in the current market environment and based on continuing discussions with the banking syndicate there will be no value for equity holders under the revised business plan and balance sheet restructure of Babcock & Brown International Pty Ltd and negligible or no value for holders of the Company’s subordinated notes.

So that's it for BNB shareholders, thanks for coming. BNB was the poster child for the leverage your way to prosperity model that has all but vanished. This was a smoke and mirrors operation that thrived on the near limitless access to cheap credit and the false assumption that asset prices always go up.

Macquarie Bank has actually been doing the same thing for longer, however they have a much stronger capital postion, lower leverage and a better ability to service their debt obligations through a more diversified revenue base. However it is difficult to see how a bank like MQG will prosper unless they radically alter the way they do business. goign forward.

Thursday, 22 January 2009

Recoupling Continues

One of the themes I outlined for 2009 was "China will NOT save us", here is what I wrote then:

The myth that Australia is somehow insulated from the global recession because it digs up rocks and sends them to the fast growing Chinese economy will be completely shattered if it hasn't been already. Economists are forecasting the Chinese economy to slow to a growth rate of around 7 - 8% in 2009, I find that far too optimistic giving the growing signs of a sharp slowdown in the Chinese economy.

The myth of decoupling has been replaced by the reality of recoupling. The Chinese manufacturing sector has contracted for five straight months, not a good sign for an economy that relies on manufacturing for more than 40% of its output.

How will a Chinese economy growing at 2 - 4% affect commodity prices and the Australian economy? That is the question that investors should be asking rather than clinging to the hope that China will plow through at an 8% run rate in the face of a global recession.

Indeed forecasts of 7 - 8% growth in the Chinese economy for 2009 seem farfetched given the latest GDP data on the Chinese economy today, From Bloomberg:

China’s Economy Grows 6.8%, Slowest Pace in 7 Years

China’s economy expanded at the slowest pace in seven years as the global recession dragged down exports, increasing pressure for more government spending and lower interest rates to buoy growth.

Gross domestic product grew 6.8 percent in the fourth quarter from a year earlier, after a 9 percent gain in the previous three months, the statistics bureau said in Beijing today. The figure matched the median estimate of 12 economists surveyed by Bloomberg News.

Plummeting Chinese demand for parts and materials for exports is reverberating across Asia and the Pacific, driving Taiwan, South Korea and Australia closer to recessions and worsening Japan’s slump. Premier Wen Jiabao said this week that the government must work urgently this quarter to reverse the slowdown and maintain social stability amid a “very grim” outlook for jobs.

“It’s an astonishingly steep slowdown,” said Paul Cavey, an economist with Macquarie Securities in Hong Kong. “We haven’t yet seen all of the pain.”

Click on the link for the full story. No doubt there is more pain to come. Economists will be ratcheting down their forecasts for Chinese growth and by implication their growth rate targets for the Australian economy.

It is widely acknowledged that Australia went into this economic downturn in better shape that most countries but does that necessarily mean it will whether the storm better given it's leverage to the Chinese economy? These are the questions investors need to ask rather than relying on the hope that things will turn out just fine.

Tuesday, 20 January 2009

Can You Say Deflation?

As repeated ad nauseum here, I believe as 2008 finished with a hint of deflation so that theme will continue in 2009. The latest TD Securities Melbourne Institute Monthly Inflation guage for December showed inflation fell -0.2% in December after falling -0.6% in November. Inflation is now up 2.2% from 1 year ago.

That is more than 1 year in advance of when the RBA had forecast inflation to come down to such levels. No doubt the RBA will be entertaining more rate cuts at their meeting in February. Presently futures are forecasting a 90% chance of a 100 bps rate cut at the February 4th meeting. That may be a bit too much, but you can expect at least another50 bps cut.

Friday, 16 January 2009

An Unprecented Age of Financial Idiocy

Seriously, could you possibly get a more incompetent gaggle of fools running major US financial corporations? The denial, obfuscation and outright lies that have continually been offered up in defense of continuing losses and write-offs have reached comical proportions.

Anyone with a clue, knew that Bank of America clearly paid too much for Countrywide and Merril Lynch. Countrywide was a disaster teetering on the brink of bankruptcy when B of A bought it. However Merril is an even more monumental blunder, given the terms of the government rescue announced today. We now know that Merril was not worth even a tenth of the $29 per share price tag B of A paid.

Much has been said about Ken Lewis, the CEO of B of A as being one of the best CEO's on Wall Street, that doesn't say much for the rest of them. Lewis' blunders in the last 12 months demonstrate that he is at best completely and utterly incompetent.

Whilst Vikram Pandit is not responsible the postion that Citigroup now finds itself. The fact that he has continually defended Citi's financial supermarket model only to turn around and start splitting up the company because it is insolvent proves that he had no idea what he was doing.

So now today the stockmarket is celebrating because the US government has made the biggest US bank a ward of the state alongside Citigroup. It makes you wonder who is stupider, the CEO's on Wall Street or stock market traders. This article siums up the sorry state of the situation, from

Government giving $20 billion to Bank of America
Guaranteeing losses on over $400 billion worth of Citi, Bank of America assets

The U.S. government on Friday announced it was injecting $20 billion into Bank of America and guaranteeing losses on over $400 billion of assets both from Citigroup and the Charlotte, N.C. lender.

In a statement released Friday, the Treasury Department and the Federal Deposit Insurance Corporation said they will invest $20 billion in Bank of America (BAC) from the Troubled Assets Relief Program in exchange for preferred stock paying an 8% dividend.

The government also will provide Bank of America protection against the possibility of unusually large losses on an asset pool of approximately $118 billion of loans, securities backed by residential and commercial real estate loans and other such assets, which have been marked to current value.

Bank of America will absorb the first $10 billion of losses while the government will share losses from there, up to $10 billion. If that pool of assets sees losses of over $20 billion, then the government will absorb hits on 90% of them.

A similar guarantee was provided to Citigroup: Uncle Sam is on the hook for $301 billion of assets, with Citi (C) taking the first $39.5 billion of hits, and then the government absorbing 90% of the rest.

The Federal Reserve also is ready to backstop "residual risk in the asset pool" if necessary.

The government relief comes as Bank of America stock skidded to a 17-year low, following Thursday's report in The Wall Street Journal that such a relief program was near. Investors were unnerved by the additional losses at Merrill Lynch.

Both Bank of America and Citigroup (C) detailed billions of dollars during the fourth quarter, and that doesn't even include the estimated $15 billion of losses from Merrill Lynch.

Thursday, 15 January 2009

Indigestion problems for Bank of America

I expended a lot of time criticizing B of A for their acquisition of Countrywide almost 16 months ago. In fact I have been critical of every one of these major takeovers such as JP Morgan's purchase of Bear Stearns and Washington Mutual.

The problem with these acquisitions is not that there are not some valuable assets up for grabs, it is that they simply paid too much for them. Every quarter, we learn that the value of assets on the major banks balance sheets are not what they were worth just one quarter ago.

Thus whatever the acquiring banks thought was fair value to pay for these assets turned out not to be. So is it any wonder that B of A is now balking at the Merril acquisition? From Bloomberg:

Bank of America May Receive U.S. Aid for Merrill Lynch Purchase
Bank of America Corp., the biggest U.S. bank by assets, may get more aid from the government to help absorb losses tied to this month’s acquisition of Merrill Lynch & Co., three people familiar with the matter said.

Details are likely to be disclosed on Jan. 20, the people said. That’s when Bank of America may post its first quarterly loss in 17 years as it digests the purchases of Merrill Lynch and Countrywide Financial Corp. The combined company has already received $25 billion from the U.S.

Bank of America, based in Charlotte, North Carolina, told regulators in December the takeover might be abandoned because of Merrill’s worse-than-expected results, said the people, who declined to be identified because the talks are private. The government insisted the transaction go forward because its collapse would create new turmoil in the financial system, they said.

“Bank of America has all kinds of problems with its acquisitions,” said Gary Townsend, president of Hill-Townsend Capital LLC in Chevy Chase, Maryland. “They’ve been so acquisitive, they find themselves with very little in tangible equity.”

The part in bold is the point here, the major banks are woefully under capitalized and as I have been saying for some time, the equity injections are not enough, they are just absorbing the losses, they are not being restored to financial health.

Again lets be clear, the major US financial institutions are insolvent, the only thing preventing their equity from going to zero is that the US government is standing behind them.

However according to Chris Whalen, who has been spot on with respect to the problems at the major US banks, the US government's presence may not be enough to stop the equity of firms like Citibank, B of A and JP Morgan from going to zero. Click on the image below to hear Whalen's latest thoughts.

JPMorgan Chase Earnings
JPMorgan Chase Earnings

Australian Employment Declines in December

The abs reported today that Australian employment fell by a seasonally adjusted -1200 jobs whilst the unemployment rate rose to 4.5%. That might not seem too bad but remember that you need 15 - 20k new jobs per month just to prevent the unemployment rate rising.

A closer look at the numbers suggest some troubling trends. 44k full time jobs were lost in December whilst 42.7k part-time jobs were added. I mentioned this full-time part-time divergence back in November. Historically in recessions and slowdowns part-time employment continues to grow or at least holds up whilst full time employment declines sharply.

2008 finished with an unemployment rate of 4.5% in Australia, expect it to be somewhere around 6 - 6.5% by the end of 2009 and expect the Australian government to have egg on their face with their forecast of 5.0% by mid year with employment growth thereafter.

Wednesday, 14 January 2009

Another Kitchen Sink Quarter for US Banks

Remember all the talk a year ago about how US financial institutions were going to have a kitchen sink quarter in 4Q07? That is they were going to take big write-downs on toxic assets to clear the decks and start fresh. That didn't work out so well as subsequently Bear Stearns and Lehman brothers folded, the remaining investment banks disappeared by becoming bank holding companies, WaMu became the biggest bank failure in history and AIG and now Citigroup were effectively nationalized.

So here we are again, just about to get earnings after probably the worst quarter so far in this recession. Once again alanysts are too optimistic with their forecasts, there will be massive writedowns and losses from the major financial instituions again. Deutsche Bank's announcement today is just a taster, from Bloomberg:

Deutsche Bank Reports EU4.8 Billion Loss on Trading

Deutsche Bank AG, Germany’s biggest bank, reported a loss of about 4.8 billion euros ($6.3 billion) in the fourth quarter after the worst financial crisis since the Great Depression pummeled its debt and equity trading results.

The bank fell as much as 8.4 percent in Frankfurt trading. The loss, which compares with a profit of about 1 billion euros a year earlier, also reflects increased provisions for debt backed by bond insurers and “other exceptional gains and charges,” the Frankfurt-based bank said in a statement today.

click on the link for the full story. Also out today a nasty report from Morgan Stanley estimating that HSBC might have to raise $30 billionand half it's dividend, from

HSBC Holdings may need to raise $30 billion

HSBC Holdings may need to raise $30 billion in equity and slash its dividend in half, analysts from Morgan Stanley said Wednesday in a research note that challenges the perception that the bank is one of the strongest in the world.

HSBC Holdings (HBC) , Europe's largest, is unusual in that it hasn't accepted cash from any government during the credit crunch.

Morgan Stanley has long had a bearish stance on HSBC, with the broker in November estimating a capital shortfall of $25 billion that it could fill by raising $15 billion in capital and cutting its dividend in half.

But now the brokerage says HSBC needs to raise between $20 billion and $30 billion and is still calling for a halving of its dividend.

The note penned by a team led by Anil Agarwal says the group's Asian franchise isn't as well capitalized as thought. By Morgan Stanley's reckoning, HSBC's Hongkong and Shanghai Banking Corp. division has one of the lowest reserves of any Hong Kong bank, and needs an extra $5.8 billion.

Plus, HSBC has already padded its U.K. and U.S. businesses by roughly $11 billion, leaving little cushion at the group level. Morgan Stanley estimates that further losses in the U.S. will require another $5 billion in equity. And it says it can't rule out HSBC not paying a dividend for two years.

There is a good chance Morgan Stanley may be wrong, but even if they are only half right a $10 - $15 billion dollar capital shortfall is no laughing matter.

As repeated here many times, the capital injections to date for major financial instituions are just the beginning, the banking sector still needs vastly more capital to restore some semblance of normalcy. Citigroup proved that point recently when they were effectively nationised with another $20 billion injection. Now out of desperation they are selling a stake in their prized brokerage operation to raise yet more capital.

Monday, 12 January 2009

Job Ads Indicate Rising Unemployment

The ANZ job ad series was released today showing further slides in job ads across all categories in December. The total number of job advertisements fell -9.7% in December and are now down -29.9% from a year go.

The ANZ job ad series has historically been a good leading indicator of employment growth in the Australian economy. The Haed of ANZ Economics Warren Hogan had this to say:

“The rate of decline in job advertising intensified in the month of December, providing further evidence that the demand for new labour across the Australian economy is now at recession levels.

“Australia has no experience of recession since we started collecting internet job ads, so all our longer-term historical comparisons are based on the newspaper series. A 50% decline in newspaper job advertising in a year is historically consistent with economic recession within the next nine months and a rise in the unemployment rate over the following years.

Newspaper ads are now down -51.8% from a year ago. However to what extent this reflects the shift from newspaper to internet is unknown and therefore comparisons to pre-internet days should viewed with caution.

However, it is clear that the unemployment rate will rathchet up in 2009. ANZ are predicting an unemployment rate of 6% by the end of 2009, that sounds about right but the risk is that it goes higher by the end of year.

Saturday, 10 January 2009

Biggest Yearly Jobs Loss Since 1945

Sounds like an alarmist headline doesn't it? It's actually not as bad as it seems. That might seem to be a strange thing to say as the US economy lost more jobs in 2008 than any year since 1945, but what isn't taken into account is the size of the labor force in previous periods.

But firstly, the December non-farm payroll report was a shocker, -524k jobs were lost in December as well as a further -167k downward revisions to October and November. The unemployment rose to it's highest level since 1993 at 7.2%.

Normally I'd give a breakdown of where all the jobs were lost but what is the point? They're being lost everywhere except in small parts of government and places like Healthcare and Education.

About the only other thing of note is that until recently job losses have mainly been in manufacturing and construction, however the service sector is now shedding jobs at a rapid rate meaning that the recession is full blown and just really kicking into to stride in the last few months.

Back to the point about putting the job losses into perspective. Take for example the -602k jobs lost in December 1974. That number is only slightly more than the last couple of months, however the total number of people employed in December 1974 was 77.7 million. Thus the number of jobs lost in that month represented approximately 0.8% of the total.

The worst month for job losses in 2008 was November (notwithstanding revisions to December) in which -584k jobs were lost. The total number of people employed in November was 136 million so the job losses in that month was 0.4% of the total.

Another way to look at it would be to say that we would need to see job losses of close to 1 million per month in current times to be as bad as some previous periods. The positive side is that, current job losses are only as bad as previous deep recession such as the early 1980's or the mid 1970's. The negative side is that they could get much worse.

The chart above shows total US non-farm employment over the last decade. As you can see, the downward trajectory of job losses in the current recession is much steeper than the previous one and is getting steeper. 2.6 million jobs were lost in 2008, You can expect that many to be lost in 2009 and thus the unemployment rate to go north of 9%.

Also be careful when comparing the unemployment rate to prior periods. We all know that unemployment reached 25% at the height of the great depression. If you want to compare to the great depression, you should use a number the BLS publishes called U6.

U6 is an alternative measure of unemployment that includes marginally attached workers and those employed part-time but that would like work full time. Another term used to describe these people is underemployed. That rate is currently at 13.5% as shown above and in my opinion headed closer to 18% before it peaks.

Friday, 9 January 2009

Wal-Mart Slashes Forecasts

The one bright spot in the US retail landscape has dimmed somewhat on the back of Wal-Mart's profit downgrade announced yesterday signaling that noone is immune from the retrenchment in consumer spending. From Bloomberg:

Wal-Mart’s Bleak December May Herald More Pain in ‘09

Wal-Mart Stores Inc., Macy’s Inc. and Gap Inc. slashed earnings forecasts after the worst holiday- shopping season in 40 years, and the retail landscape may not improve heading into 2009.

Wal-Mart, the world’s biggest retailer, today said fourth- quarter earnings will be at most 94 cents a share, down from a November projection of as much as $1.07. Sales at stores open at least a year rose 1.7 percent last month, missing the 2.7 percent average of analysts’ estimates compiled by Retail Metrics Inc.

To attract customers amid rising unemployment and tightening credit, some U.S. retailers cut prices in December by as much as 70 percent. That threatens to erode profit margins in the fourth quarter, the most important of the year. The discounting may continue this year as the stores try to clear inventory.

“Consumers have become so accustomed to markdowns that nobody wants to pay full retail anymore,” said Craig Johnson, president of retail-consulting firm Customer Growth Partners LLC in New Canaan, Connecticut. “There’s going to be profit pressure in the first quarter.”

U.S. December same-store sales dropped 1.7 percent, the International Council of Shopping Centers reported. The New York-based trade group said sales declined 2.2 percent in the last two months of the year, the biggest such drop since it started tracking the data in 1969.

Thursday, 8 January 2009

Australian Economic Roundup

If you want a quick gauge of economic activity in Australia it's worth visiting the Australian Industry Group's Economic sector survey's at the beginning each month. Firstly lets take a look at the Manufacturing sector:

  • Manufacturing activity fell for a seventh month in a row in December, though at a slightly slower pace than in November. Capacity utilization fell to its lowest level in 16 years.
  • The seasonally adjusted Australian Industry Group-PricewaterhouseCoopers Australian PMI® rose, by 1.0 points, to 33.7, still well below the 50 point mark separating expansion from contraction.
  • All components remained below 50 points indicating falls in the levels of each indicator. New orders and employment fell, though at a slower rate than in November, while production, inventories and supplier deliveries fell faster than in November.

Secondly the Service sector:
  • Persistent weak demand led to a ninth consecutive monthly decline in services sector activity in December.
  • The seasonally adjusted Australian Industry Group/Commonwealth Bank Performance of Services Index (Australian PSI®) rose marginally, by 1.5 points to 39.3, but remained below the key 50.0 level separating expansion from contraction.
  • The slight moderation in the rate of decline in services activity was largely due to softer falls in the property & business services and transport & storage sectors. This largely reflected a marginal improvement in the property market; demand for transport services in the lead-up to Christmas; and lower fuel costs.
  • Sales, new orders and inventories all decreased at a slower rate in December, with the pace of job-shedding remaining broadly steady. Capacity utilisation rose slightly, while input cost increases moderated further.
Finally the Construction sector:
  • The national construction industry registered a further decline in December, as firms continued to be severely affected by the economic and financial crisis and deteriorating demand.
  • The further fall in construction activity was attributed to poor demand conditions and a lack of new project work. This was mainly linked to the adverse state of economic and financial conditions and negative client sentiment. It was also noted that intense competition for new contracts had persisted, resulting in a high failure rate for tenders and diminishing order books.
  • The seasonally adjusted Australian Industry Group/Housing Industry Association Performance of Construction Index (Australian PCI®) fell by 1.1 points to 30.9, to remain below the critical 50 points no-change level for a 10th consecutive month.
  • The latest decline was underpinned by continued falls in activity across all major sectors. House building remained the worst performing sector (although its reduction was less marked than the previous month), while rates of decline picked up in engineering and commercial construction.

Manufacturing has been contracting for 7 straight months, the service sector for 9 months and the construction industry for 10 months. However the RBA and most goldilocks economists think we will avoid recession.....OK then.

Also out today, building approvals fell a seasonally adjusted -12.8% in November and are now -35% lower than they were one year ago. The level of building approvals has fallen back to levels last seen in March 2001. So what does all this mean? The recession train has clearly left the station folks.

ADP Report Indicates Jobs Disaster in December

The ADP employment report released on Wednesday points to a huge drop in non-farm payrolls in the month of December. Note that whilst the ADP report has generally been underestimating the extent of job losses reported by the BLS, they have revised their methodology so that it is now more correlated with the BLS numbers. From the report:

Nonfarm private employment decreased 693,000 from November to December 2008 on a seasonally adjusted basis, according to the ADP National Employment Report®. This month’s ADP Report incorporates methodological improvements intended to improve the correspondence between the nonfarm private employment estimates shown in the ADP Report and estimates published in the Bureau of Labor Statistics’ Employment Situation Report.

December’s ADP Report estimates nonfarm private employment in the service-providing sector fell by 473,000. Employment in the goods-producing sector declined 220,000, the twenty-third consecutive monthly decline. Employment in the manufacturing sector declined 120,000, marking its twenty seventh decline over the last twenty eight months.

Large businesses, defined as those with 500 or more workers, saw employment decline 91,000, while medium-size businesses with between 50 and 499 workers declined 321,000. Employment among small-size businesses, defined as those with fewer than 50 workers, declined 281,000. Sharply falling employment at medium- and small-size businesses clearly indicates that the recession has now spread well beyond manufacturing and housing-related activities.

Estimating the non-farm payroll numbers has always been a guessing game but as the losses become larger it becomes even more so. As usual watch for the revisions to prior months as well as the headline number on Friday when the BLS releases it's report.

Wednesday, 7 January 2009

Aussie Retail Sales Limp Forward in November

In trend terms, Retail Sales in Australia rose 0.1% in November and are up just 1.9% from one year ago. That is the lowest year over year rise in trend retail sales since the abs began compiling data in April 1982. This time last year retail sales were ticking over at more than an 8% annual growth rate.

Although annual general meetings can be rather boring affairs, it is worth reading the Chairman's address to shareholders every November. If like me, you read a few of the retailers addresses during the recent AGM season, there was not much cheer going around and for good reason.

Australian retailers are going to have a tougher 2009 than they did in 2008. As the great deflationary debt unwind continues Australian consumers, like their US counterparts are going to reign in their spending, whilst credit availability is curtailed and unemployment rises.

However, that hasn't stopped a nice rally in the shares of discretionary retail stocks. Whilst the All Ordinaries index is up 16.5% from the intraday low on November 21st, many major retailers are up significantly more. JB Hifi (JBH) is up almost 50% from it's intraday low whilst Harvey Norman (HVN), which has been doing it tougher than most, is still up 27%.

That's some pretty nice gains if you were lucky enough to pick them up close to their respective bottoms. It's natural to feel like you've missed the boat when see gains like these. Especially when more bullish commentary is starting appear in the media. But is that a reason to buy stocks or is it a reason be cautious?

Retail earnings will no doubt disappoint in 2009 as the Australian economy comes under more strain than most economists are currently forecasting. Thus you may just get another chance to buy these stocks at or close to their prior lows.

Saturday, 3 January 2009

Themes and Predictions for 2009

Firstly lets have a look at predictions I made at the beginning of last year.

  • The All Ords will not do as well in 2008 as it did in 2007.
  • The Nikkei will do better.
  • The Hang Seng will do worse.
  • Shanghai will do worse.
  • The US indices will put in negative returns.

Obviously the prediction for the Nikkei turned out to be way of base, down -11% in 2007 followed by a -42% decline in 2008. All other predictions were right, but to be fair one really can't claim a great degree of accuracy by saying the XAO would do worse in 2008 than 2007 given the -43% decline in the XAO in 2008 compared to a rise of 14% in 2007. However I will take credit for the call on the US given that Wall Street overwhelmingly saw the S&P500 rising in 2008.

So what will 2009 bring? Before making predictions for next year, lets take a look at some of the themes that will, in my opinion will be dominate in 2009.

Deflation to persist
Deflation reared its head in 2008 as predicted. However even in the midst of the biggest deflationary unwind since the great depression economists and market pundits continue to talk about inflation. With the Fed at 0% and seemingly printing money hand over fist it might seem like a fair call. However, notions of inflation are premature.

Few seem to remember that Japan embarked on one the biggest monetary expansions in history during 'the lost decade' and inflation was nowhere to be seen. Consensus seems to be that the treasury market is the last remaining bubble and they might be right. However, consider that the last time 10 year US treasuries went below 3% they stayed there for 24 years. That is worth thinking about in comparison to all the chatter you currently hear about buying property now because interest rates won't stay this low for very long.

While the RBA was flapping on about inflation I was talking about the RBA cutting rates to 3.0%. Now that the RBA has cut 3 full percentage points from the official cash rate in the second half of 2008, I'm probably on the high side, don't be surprised to see the RBA cash rate with a 2 handle on it. The futures markets have priced in 2.5% by mid 2009, that sounds about right to me, with the caveat that there is risk to the downside.

China will NOT save us
The myth that Australia is somehow insulated from the global recession because it digs up rocks and sends them to the fast growing Chinese economy will be completely shattered if it hasn't been already. Economists are forecasting the Chinese economy to slow to a growth rate of around 7 - 8% in 2009, I find that far too optimistic giving the growing signs of a sharp slowdown in the Chinese economy.

The myth of decoupling has been replaced by the reality of recoupling. The Chinese manufacturing sector has contracted for five straight months, not a good sign for an economy that relies on manufacturing for more than 40% of its output.

How will a Chinese economy growing at 2 - 4% affect commodity prices and the Australian economy? That is the question that investors should be asking rather than clinging to the hope that China will plow through at an 8% run rate in the face of a global recession.

US 2nd Half Recovery that will not be
Remember the second half recovery of 2008 that never was? Well the consensus view of economists and market pundits are predicting another second half rebound in the US economy in 2009. For the record, I believe most economists should be viewed as a source of light entertainment rather than any credible source of information. Thus the consensus can be almost always ignored but it is not enough to be a contrarian just for the sake of it.

The consensus view is that the monetary measures undertaken by the Treasury and the Fed combined with the pending fiscal stimulus will help the US economy climb out of the doldrums. It was also the consensus view if you recall, that the fiscal stimulus of rebate checks would get the economy back on track last year. It was also the consensus view at that time that the US economy was not in recession although it had been for 6 months.

The stimulus will take a long time to get off the ground and will have the effect of cushioning the recession rather than restoring growth. Unemployment in the US will continue to rise toward 9% during 2009 as the economy weakens further under pressure from a financial system on life support, a weakening global outlook and the continuing retrenchment of consumer spending.

One economist that has been worth listening to is Martin Feldstein. He was in front of the Fed in mid 2007 telling them that they were going to be cutting interest rates and was well ahead of the pack on the recession call.

Click on the image below for his latest interview on CNBC in which he expresses the view that we will be lucky if the US economy is turning up by this time in 2010.

Martin Feldstein
Martin Feldstein

US Earnings weaker than most expect
With just one quarter to go, S&P500 Operating Earnings forecasts for FY08 are expected to come in at about $66. I expect it will closer to $64as the fourth quarter will be weaker than expected, however a couple of dollars is of little importance. What is more prescient is the outlook for 2009.

Currently estimates for 2009 S&P500 Operating Earnings are approximately $82. That would be about 24% higher that 2008. However, as can be seen from the graph below, those estimates are coming down sharply. No-one in their right mind expects earnings of $80 next year, bearish analysts are looking for closer to $60 as a worse case scenario. My bet is S&P500 Operating Earnings will be closer to $50 with risks to the downside.

What started out as a financial crisis has now spread to the broader economy and that will show up in reduced earnings for non-financial companies. In addition financial companies will continue to post losses as writedowns persist and delinquencies on all types of loans ratchet up. In Australia, expect first half 2009 earnings to be weaker than expected and outlooks to get increasingly gloomier.

Bankruptcies to Ratchet up

25 US, FDIC insured banks went belly up in 2008 up sharply from the low levels of recent years. There will be more than 25 in 2009, that is almost a given. However the markets have become used to the FDIC announcements of failed banks on a Friday afternoon. What they haven't gotten used to is large scale bankruptcies in the retail sector. To be sure some retailers, went out of business in 2008, Linen & Things being one of the most high profile to go bust.

2009 will see many more retailers go out of business as consumer spending stays weak. Simply put, just as there are too many houses in the US and too many cars produced by an overcapacity in the auto industry, there are just too many retail stores to service a tapped out US consumer.

Home Prices Continue to Fall in 2009.
It would be remiss not to include a prognostication for the the market where many of the problems showed up first. Whilst sales of new and existing homes in the US break new records to the downside each month, there is still a huge amount of unsold inventroy on the market that will continue to pressure prices.

The chart above comes courtesy of the Contrary Investor and shows the number of vacant single-family homes relative to all single-family homes. Bascially such levels are unprecedented.

According to the Case-Shiller Home Price index, US home prices are down -23.4% from their peak. Regardless of the successful efforts by the Fed to lower mortgage rates, until that unsold inventory of homes starts to meaningfully decline, prices will continue falling.

There has been a continual chorus of bottom calling in home prices for at least 18 months and whilst they will eventually be right I doubt it will be until the end of this year at best.

In Australia, the government's attempts to shore up the property market with new home buyer grants is simply propping up prices that need to come down to restore a more equitable ratio between income and house prices.

It will be interesting to see what happens to home sales when the grants expire in June 2009. My bet is the government cannot stop an overdue correction in Australian home prices, but we should be prepared for the government to continue trying.

Changing Social mood
Social mood will increasingly darken, frugality is in and extravagance will be shunned. The optimism surrounding the borrow your way to prosperity environment of the last decade will seem ridiculous in retrospect.

Heightened Geopolitical Risk
Hardly a surprise, geopolitical unrest goes hand in hand with economic turmoil. I have no particular views on where things will get worse, just that they will get worse and there will be a few surprises.

Whilst none of the above themes seem terribly optimistic, one thing that is positive is that stock prices are now attractively valued. Not as dirt cheap as some pundits suggest but the cheapest they've been for a couple of decades.

Stock Market Forecasts:
Firstly, all forecasts should be taken with a grain of salt regardless of who makes them. Taking yourself and your predictions too seriously should be warning sign. Thus my investment decisions do not rely on these forecasts being met. I am also loathe to give a specific number but rather a range. Years in the broking industry taught me that price targets are meaningless and thus a target for the market is of little use.

Also of note is that market forecasters are overwhelmingly bullish on 2009. In a recent survey just 6% of forecasters believe the S&P500 will finish lower in 2009. It should be noted that last year the average forecast for 2008 for the S&P500 was around 1600.

In a year when the market fell -43% it is hardly risky to make the prediction that the following year will be better. As I've outlined in the last month or so, I believe the All Ords is yet to see its ultimate bottom in this cycle. I have no idea when the bottom will come but I believe it is still ahead of us in 2009. I think it is entirely possible that XAO will have a 2 handle sometime in 2009.

It will also be a year of huge volatility as 2008 was. I believe we will see at least a couple of false dawns as we saw in 2008, or more simply, strong rallies that ultimately fail. That said, I wouldn't be surprised if the market finished higher in 2009 but not much higher. I have a tentative range of about 10% either side of where the XAO finished 2008. So somewhere between 3300 and 4000 with wild swings well outside of that range during the year.

Thursday, 1 January 2009

XAO Posts Worst Yearly Performance Ever

Firstly a look at December, last month I thought we might get a rally into the new year, certainly we had a rally in the last few days of December but it wasn't enough to turn the XAO positive for the month, the ALL ORDS finishing down -0.4%.

However the real story was that the XAO finished down -43.0% for the year, that's the worst performance for the index, ever. There were only 3 months in 2008 that finished up for the XAO and three times the XAO fell more than ten percent in a single month.

2008 also saw a cascade of events that noone would have thought possible at the beginning of the year. The US investment bank industry disappeared, home prices and sales fell by record margins. The effective nationalization of a large part of the US financial system, zero interest rates from the Fed, and the list goes on.

In Australia the RBA did an about face on interest rates slashing the overnight rate by 3% as the reality hit home that we cannot decouple from the United States because we dig up rocks and export them to China. The silly fears of inflation have now turned to fears of deflation as I expected they would.

Still, there is a lot of denial about in Australia and on some level that is understandable, unemployment is still low and house prices while falling in some parts of the country have fared much better that other developed countries. Is Australia different or are we just lagging the US and the rest of the world? I'd say it's a bit of both.

So what will January bring? As noted a few times, we are yet to have a sustained bear maket rally. A pattern has played out in the last few months where the index sustains big losses in the beginning of the month and rallies toward the end. Certainly December saw a decline in volatility and an easing of fears.

Although January will bring another horrible payroll report in the US, the worst GDP reading for 25 years and the worst corporate earnings number for the S&P500 so far in this down cycle, the excitement around Obama's inauguration could give the market's a boost. Whilst I don't have much faith in the economic policies outlined by the incoming administration, the inauguration can do enough to spur sentiment in the short term.

So I'll call the XAO higher in January with the usual caveat that my predictive powers are no better than anyone elses when it comes to short term market movements. Looking further out I still believe we will hit new lows in the stock market some time in 2009. But I will post more on the likely themes for 2009 in the next couple of days. For now, don't forget to vote in this months poll.