Thursday, January 1, 2009

Outlook 2009: Post Deleveraging Blues?



I want to wish all of you a Happy New Year. I hope you and your families enjoy many years full of health and happiness and my best wishes for 2009.

Given it's the first day of the year and it's freezing here in Montreal (I knew I should have gone to Greece during the holidays), I thought I would share with you my outlook for 2009.

But first, you should probably skim over this article looking at the market winners and losers for 2008. Fox Business interviewed the billionaire investor Wilburt Ross yesterday to get his outlook for 2009.

Mr. Ross recommends tax free municipal bonds as "one of the the cheapest asset classes in existence" because you can buy high quality munies with 6% coupon totally tax free. As marginal tax rates rise under the Obama Administration, this investment makes sense to him.

On the stock market, Mr. Ross thinks the market is more likely to be higher a year from now but it will be a bumpy and volatile ride because "the economy will continue to go down."

As far as the prospects for a Japan-style deflationary episode, Mr. Ross thinks it is highly unlikely because "inventories are low" and once consumption picks up, there will be a "V-shaped recovery sometime in 2010."

As far the Obama Administration's stimulus program, Mr. Ross thinks it has to deal with the housing market and it has to bolster confidence for it to be effective.

So what do other financial experts think about 2009? Take the time to read Kiplinger's Outllook 2009:

Clearly 2009 will be a dreadful year for the economy, but what about for the stock market? Perhaps not quite as bad, for the simple reason that stock prices already reflect a severe recession. From the market's 2007 top through December 1, 2008, Standard & Poor's 500-stock index plummeted almost 48%, a collapse that is up there with the most ferocious post-World War II bear markets.

David Wyss, S&P's chief economist, estimates that operating earnings of S&P 500 companies will decline 4% in 2009, following a 20% drop in 2008. Stocks are likely to trend downward and remain volatile at least through the first quarter of the year, as investors fixate on the rapidly deteriorating earnings picture and the shaky financial system.

Still, after a rocky start, the U.S. stock market could gain 5% to 8% for the year. How can that happen in light of all the gloomy economic news? Stocks typically begin to rebound three to six months before the start of an economic recovery, often when the news is still dismal. Kiplinger's expects the economy to shrink for at least the first two quarters of 2009, followed by tepid growth the rest of the year.

If President Obama and the new Congress enact massive public-works projects and take other steps to stimulate the economy, the recession could end a bit sooner and the recovery could be somewhat stronger. As a result, corporate profits should start to recuperate in 2010, and the stock market, looking ahead, could begin a sustained recovery in the second or third quarter of 2009. Wyss projects earnings growth of more than 10% in 2010.

Many segments of the bond market may be more attractive than stocks in 2009. Dysfunctional credit markets have created distortions and alluring values in a number of bond classes, says Brian McMahon, chief investment officer of Thornburg Investment Management. "It's the greatest liquidation sale in history in bonds," he says.

Slow growth ahead

The U.S. could be in for years of sluggish economic growth because it will take years to flush out the system. Among the main drags on the economy in 2009 (and beyond) is the savage deleveraging of the U.S. financial system and household balance sheets. Deleveraging -- paying down debts -- is an ugly word for an ugly, painful and strongly deflationary process.

The nation didn't reach this point overnight. U.S. indebtedness has risen relentlessly for 25 years, and the rate of increase went parabolic this decade, inflated by the mother of all credit bubbles. Wall Street firms, banks, insurers and hedge funds leveraged up with reckless abandon, and now the country's financial arteries are clogged with the sludge of bad debts.

As banks purge debts and repair their devastated balance sheets, they must curb lending, which will be painful for businesses and consumers. Goldman Sachs, which estimates that a half-million workers in the overgrown financial sector will be laid off in 2009, notes that 30% of S&P 500 profits in recent years came from financial companies. That's twice the historical norm. Says Jeremy Grantham, a founder and director of GMO, a Boston money-management firm: "We have had a bloated financial industry feeding off the real economy."

As on Wall Street, U.S. households are like credit junkies. Americans have borrowed and consumed well beyond the growth in real income for many years, a trend reflected in the dramatic widening in our current-account trade deficit, which has quintupled this decade, and our burgeoning foreign debt. Wyss notes that the ratio of household debt to after-tax income has jumped this decade from 100% to an unsustainable 139%.

So overextended consumers will go on a crash diet in 2009 and beyond as they service and curb debt and boost savings. They'll have little choice. Credit will be less readily available and pricier. More frugal, less indebted consumers are ultimately healthy for the economy, but decreased spending will crimp growth in the near term and suppress economic recovery.

Some numbers to illustrate the dynamic: In 2007, consumption accounted for an economically unhealthy 70% of gross domestic product. Some economists, such as Keith Hembre, of First American Funds, think the ratio needs to revert over a period of years to the historical norm of 66% through a multiyear adjustment. That implies a contraction in consumer demand of about $600 billion annually.

Let's not count on any help in 2009 from the housing market, which kicked off the financial debacle. Home prices are down more than 20% from their peak in mid 2006, according to the Case-Shiller index, which tracks prices in 20 large cities, but we think they'll fall at least 10% more, on average, before possibly bottoming in 2010.

The imbalances are too great to expect a more-benign outcome. Foreclosures and delinquencies are surging. Excess inventories are enormous. Home prices are still high by historical standards relative to household incomes and rents. Rising unemployment puts the squeeze on homeowners. Some economists project that by the end of 2009, a frightening 40% of U.S. homeowners with mortgages will owe lenders more than their homes are worth. It's hard to imagine a sturdy recovery and a turnaround in banking and the economy before housing stabilizes.

As bleak as the economy looks now, there are some hopeful signs. The collapse of energy prices is like a massive tax cut for U.S. consumers (for every penny that gasoline prices decrease, purchasing power increases by $1.4 billion). Declines in the price of oil and many other commodities are taming inflationary pressure, which should help keep interest rates low.

The Treasury's financial rescue package should begin to bear fruit in 2009. Once the banks get back on their feet and start lending again, the beneficial effects of the Federal Reserve Board's dramatic interest-rate reductions (to 1% on the central bank's key overnight lending rate) should start to ripple through the economy.

The China factor

We'll see government stimulus packages here and abroad. In early November, China, which is now as important to global economic growth as the U.S., announced a massive, $586-billion spending program to invigorate domestic demand. China's situation is the mirror image of the U.S. predicament: It has excess savings, huge foreign-exchange reserves and a strong fiscal position. And the Chinese have the muscle to pump up spending to counter an economic downturn.

As U.S. consumers retreat and rebuild their balance sheets, the emerging markets, with their rising middle classes, will pick up the slack over the medium and long term. U.S. export growth will weaken in 2009 (in part because of the surprisingly robust dollar), but import growth will weaken more dramatically.

So how should you invest in dour 2009? As always, that depends on circumstances such as age, wealth, risk tolerance and time horizon. If you're within a few years of a particular goal -- say, the year you face your child's first college-tuition payment -- don't even consider investing that money in stocks.

If you're in your twenties or thirties, this is an excellent time to start investing for retirement. You cannot predict the bottom. But low stock prices are wonderful for the long-term, buy-and-hold investor, and by several historical measures, such as dividend yield (about 3.4%), cash on the sidelines ($3.7 trillion in money-market funds) and price-earnings ratios, the market seems reasonably valued today. (Market forecaster Steve Leuthold says that at the October 27 low, the S&P 500 was in the bottom 15% of its valuation history over the past 52 years.)

GMO's Grantham -- often called a perma-bear because he was down on stocks for so long -- now reckons that U.S. stocks are attractive for the first time in two decades. Grantham, who ten years ago projected the past decade's disastrous market returns with uncanny accuracy, thinks U.S. stocks should return an annualized 6% plus inflation over the next seven years. That would put the market on track to approach its long-term return of 10% annualized. "The U.S. is decently cheap," says Grantham. "Super-high-quality U.S. blue chips are now very cheap." He projects even higher returns for foreign stocks.

Grantham is bullish in the long term, but he cautions that bear markets typically overshoot fair value on the downside. So be sure you can stomach another drop of 10% to 20% before you take the plunge for the long term. Grantham suggests filtering money into the market over a year or two.

Panic-selling has created some great opportunities in stocks, but no one knows when investors will regain their appetite for taking risks -- one of the keys to a sustained advance. "They don't ring a bell at the bottom," says John Buckingham, manager of Al Frank Fund. "The best time to buy is when everything looks awful."

The main point is that the U.S. (and global) economy will decelerate in 2009 and stocks can undershoot to the downside even more before they recover. The Kiplinger article ends with some excellent stock recommendations.

In his 2009 Outlook, David Dietze, CIO of Point View Financial Services, wrote an article for Guru Focus recommending Anything But Treasuries (ABT) following Annus Horribilis:

2008 was marked by the complete failure of diversification strategies.

Compare the Nasdaq led downturn of 2000, when value stocks like energy and financials offered a safe haven. Then, while the Nasdaq sank 39% a portfolio of small cap value stocks climbed 23%.

This time around, there was no place to hide. Diversifying overseas disappointed investors looking for shelter from the effects of plunging US residential real estate prices. Foreign equities were down on average 48% by late December.

Small stocks, thought to be particularly vulnerable because of less access to credit, sank 37% as measured by the Russell 2000, pretty much in lockstep with large cap stocks, as the Dow itself tumbled a similar 35%. Investors did not discriminate between value and growth stocks, as the Russell Value index declined 40.07% by late in 2008, almost identically with the Russell Growth’s swoon of 40.3%.

Even economic sectors with traditionally defensive characteristics could not advance, although losses were somewhat less than more economically sensitive sectors. For example, Fidelity’s Consumer Staples fund was down “only” 25% by late 2008, outperforming somewhat its Consumer Discretionary fund, down 35%.

Diversification into fixed income generally was a loser. High grade corporate bonds tanked, even after adding back the income, by 7%, while low quality junk bonds arguable suffered through their worst year on record, down 31%.

Muni bonds suffered from the same litany of concerns affecting the rest of the market: Suspicions over their credit quality, fears over how sinking real estate prices and weak employment trends would affect tax collections, and low liquidity exacerbated by an outright refusal of some Wall Street banks’ trading desks to continue making markets. An index of these bonds sank 14% in 2008.

Commodities proved to be a loser, too, as the great deleveraging process scuttled all assets other than those that could be used to repay debt, namely US Dollars. Oil had a tremendous rise in the first half of the year, but then plunged in record fashion, losing nearly ¾ of its value in some 5 months.

Despite the mother of all financial crises in the post war period, investors did not go for the gold in 2008; it eased 3% through late December. While it did temporarily top $1,000 an ounce in March in connection with the collapse of Bear Stearns, investors felt little need to hold the yellow metal as the US Dollar strengthened and investors demanded only assets that could be used to pay debts (cash) or had guaranteed convertibility into cash (US Treasury bonds).

The winner for 2008: US Government bonds. Inflation became a no show, interest rates declined, and the return of principal become more important that the return on principal. Long dated ones rose over 30% by late 2008.

The US Dollar advanced nearly 5% against a basket of other currencies, as investors fretted that the financial crisis’ effect on other countries would be worse than its effects here. The Japanese Yen also fared well, rising 28% versus the US Dollar.

Many speculators had borrowed at very low rates in Japanese Yen and reinvested in higher yielding US junk bonds, leveraging their bets by up to a factor of 50 in the process. When those bets soured, and the value of the Yen started to soar, the massive rush to unwind those trades caused massive appreciation of the Japanese currency.


Advice for 2009

Amid the massive deleveraging and economic panic, many investors have become forced sellers. Hedge funds are selling as their bankers terminate credit lines, mutual funds are liquidating to meet redemption requests, individual investors are pulling the plug on even their IRAs to pay off bills, while small business owners sell to keep the family enterprise operating. Some charities are selling because their portfolios securing many of their annuity obligations have so declined that further deterioration cannot be tolerated. These are forced sales, without analysis as to their merits.

If you are not among the misfortunate forced sellers, do not get into the line to sell. Distressed sellers do not get good prices. If you’ve got the gumption, take advantage of those forced sellers. While the future is uncertain, as it always is, we do know prices are as much as 60% off from those prevailing in 2007. That puts the odds in your favor to make some serious money over the next 5 to 10 years. As Warren Buffett says: Be greedy when others are fearful.

What to buy? Usually, the investment experts advise extreme selectivity. While selectivity is always helpful, this is one of those rare moments when investing in anything other than cash or Treasury bonds will prove profitable. As everything else has declined severely, nearly all of it can be expected to turn profitable once confidence and liquidity returns.

Why the Weakness?

Following the horrific events of 9/11 and the popping of the internet bubble, monetary authorities worldwide injected massive amounts of liquidity into the system, pushing short term lending rates down as low as 1%. This liquidity shunned the public equity markets, being skeptical of prospects and valuations, but found a home in residential real estate markets.

Record low interest rates and lax lending standards helped stimulate robust and bubble-like real estate markets. The mantra that there’s never been a nationwide real estate downturn stimulated buying interest in US residential real estate mortgages worldwide, with the thinking that diversified portfolios of US mortgage backed securities was a prudent way to generate excess yield.

Subsequent monetary tightening to reduce an overheated economy soon put pressure on home prices, mortgages secured by them, and entities specializing in this area. The mortgage lending leader Countrywide narrowly averted collapse; Bank of America bought it at a distressed price.

By March 2008, Bear Stearns, heavily exposed to real estate, was bought by JP Morgan at a fire sale. However, the deal was only consummated by the Federal Reserve’s willingness to backstop some of Bear’s most toxic assets.

By late last summer Government sponsored entities Fannie Mae and Freddie Mac were effectively nationalized, as their core capital was essentially depleted by soured residential real estate loans. The world’s largest insurance company, AIG, met a similar fate as it could not meet requirements to post additional collateral to support its corporate debt guarantees.

Investors were shocked at the collapse of Lehman in September. Despite its being larger than Bear Stearns, this time the Federal Government offered no assistance, no buyer came forward, and both Lehman’s stock and bonds became virtually worthless.

Several money market funds owning short term Lehman paper either “broke the buck” or threatened to, meaning having to tell investors that they could not maintain a constant $1 per share value. Investors started yanking funds from money market accounts, insisting on holding only US Government paper, frightened that their short term cash holdings, needed for their day to day operations, were at risk.

This made private sector issuance of high quality short term paper nearly impossible, and corporations and individuals started hoarding cash and deferring all but the most critical expenditures. Markets plunged, economic activity weakened.

However, investors are now taking comfort in Governmental actions to restore liquidity and confidence. Critical developments include legislation for expenditures of up to $750 billion to shore up the financial system. Citigroup received a very generous relief package helping it avert failure. GM and Chrysler secured up to $17 billion in short term funding.

Bleak Economic Outlook

There’s no question, the economic outlook is challenging. Recession started last year at this time, and GDP could drop some 4% in 2008’s fourth quarter. While economists expect some relief by 2009’s second half, the current recession could still be the longest in post war history.

Unemployment could rise to 8%, the worst since the 1970s. While this is a lagging metric, consumer spending still constitutes some 70% of the economy. Job market weakness will put a major damper on spending.

Home prices, the epicenter of the current crisis, have yet to stabilize. Most non-Governmental debt is trading, if at all, at record spreads over Treasuries, bringing borrowing to a halt, crimping plans for capital expenditures.

Overseas economies are weakening fast, putting a damper on the source for 40% of the S&P 500’s revenues, amid recent trade reports show slowing US exports. While investors cheered the recent emergency financial assistance extended to GM and Chrysler, millions of jobs are tied to whether Detroit can restructure their businesses sufficiently to survive.

What Do the Financial Markets Now Discount?

Still, investors have to ask themselves what is now priced into stock prices? If “Armageddon” is now discounted, the downside risk of the continued drum beat of bad news may be less than the upside potential should economic collapse not occur.

The decline in stock prices rivals anything seen in the post war period, with the major market averages having declined over 50% from their October 2007 peaks. The proverbial mattress, US Treasuries, is now offering record lows yields, close to (or even below) 0% for very short maturities, the lowest since records started being kept in 1934.

Commodity prices, a barometer of economic health, have just suffered through one of their steepest declines on record. The dividend yields on the stock market now exceed by a wide margin the yield on the 10 year Treasury, reflecting great skepticism that the dividend payouts can be sustained, even though historically they’ve grown some 6% annually.

Sign Posts

Watch these clues on the stock market’s direction in 2009. The risk premium on (the spreads over) non Governmental debt relative to Government debt: Short term LIBOR rates have tightened up considerably since October, indicating less fear in the market, while 30 year home mortgage rates have declined, a boon for the real estate market.

The price of crude oil: Its recent fall, including the price of gas at the pump, translates into a massive tax reduction for the economy, but further falls may indicate economic weakness, spooking investors.

A continuation of the market’s recent rally: It has led to a technical end to the bear market as the S&P has climbed over 20% since its 11/20 lows. Also, the VIX, a gauge of fear and volatility, has retreated significantly from its November extremes.

Developments in Washington: The massive dose of fiscal stimulus being promised by President elect Obama may jump start spending and boost confidence, while the last minute reprieves in the form of financial assistance to the automakers may allow the economy to avoid the shock of a Detroit collapse.

Monetary developments: Look for continued rate cuts by the Federal Reserve, but with rates approaching zero, it must creatively find other ways to stimulate the credit markets, like expanding its recently announced programs to buy mortgage and consumer related debt.

In sum, 2008’s awful performance discounts a lot of the bad forecasts for 2009. Just slightly better than expected economic news, coupled with miserly returns on cash and Treasuries, could jump start 2009.

So the big question is how much of the bad economic news is already discounted in the current stock market valuations? Moreover, even if stocks got slaughtered last year, will they undershoot to the downside?


To help us answer these questions, I think it is worthwhile reading an excellent academic paper recently produced by Jonathan Nitzan and Shimshon Bichler called Contours of Crisis: Plus ça change, plus c'est pareil?


In their introduction, Professors Bichler and Nitzan note the following:

This paper sets the stage for the series. It outlines the conventional wisdom about the cause of crisis; it describes the chronology of events; and it contrasts the pattern and magnitude of the current downturn with those of earlier episodes. The overall picture painted by this analysis is highly stylized: crises appear to come and go with remarkable regularity, their oscillations are fairly similar and they share the same order of magnitude. The whole process seems almost “automatic,” and automaticity is reassuring: it suggests that the current crisis has run much of its course and that doom and gloom will soon give way to a new upswing.

But what if this automaticity is a mirage?

Their main findings support their contention:

As it turns out, there is no general definition for a bear market – let alone a “major” one. So we’ve devised our own. In what follows we define a major bear market as a multi-year period during which stock prices, measured in constant dollars, move on a downtrend, and in which each successive peak is lower than the previous one.


According to this definition, over the past two centuries, the United States experienced six major bear markets. These periods are listed in Table 2 (click first chart above), along with the cumulative declines in stock prices.


A similar picture emerges from Figure 5, which measures the annual growth rate of the stock market index (again, in constant dollars). The thin line in the chart shows the percent variation from year to year. The thick line smooths these variations as a 10-year moving average – meaning that every observation in the series measures the average annual growth rate in the previous ten years.


The last data points in Figure 5 are for 2008 (click on second chart above). The year-to-year change shows a drop of 40% – on par with the record declines of 1917, 1931, 1937 and 1974. Furthermore, as the moving-average series indicates and Figure 4 confirms, this decline wasn’t a fluke event, but rather part of a decade-long bear market. According to the smoothed series, the market peaked in 1998, with the 10-year moving average growth rate hovering around 13%. From then on, annual growth rates decelerated, and by 2008 pushed the 10-year moving average down to nearly –4%.


To the eyes of a seasoned financier, these magnitudes mean that the crisis may be approaching a bottom. According to Figure 5, prior crises were similarly bounded. Their highest starting point, measured by the 10-year moving average series, was 13% (in 1929 and in 1959), and their lowest trough, measured by the same series, was –8% (in 1920). The extent of deceleration in growth rates, measured by the peak-to-trough difference of the 10-year moving average, ranged from a low of 6.5% (dur-ing in the 1834-1842 crisis), to a high of 15.5% (in 1928-1948).


The present crisis, measured by the 10-year moving average series, has already met or exceeded these extreme values. It started from a record ceiling of 13.3%; its current low is –3.6%; and the extent of its deceleration, computed as the difference between these two values, marks a new record: 16.9%. For long-term investors, these numbers indicate that much of the crisis is probably behind them.


And the news gets even better. According to Figure 4, historically, each major bear market was followed by a long bull run, and each of those bull runs pushed stocks to a new record high. These upswings occurred in 1842–1850, 1857–1905,1920–1928, 1948–1968 and 1981–1999, and it isn’t far fetched to think that a new one may soon be brewing.


Given that the present bear market is approaching historical lows, and since pre-viously such bottoms were always followed by major upswings, many forward-looking strategists – from permanent bull Barton Biggs, to Wizard of Omaha Warren Buffet, to doom-and-gloom Martin Wolf – are now advising their followers to fasten their seat belts.10 News from the so-called “real economy” is likely to remain very bad and may possibly get worse – but most of the negatives are already “in the price.” And since fictitious capital is notorious for “overreacting,” particularly during deep downturns, current stock prices offer a once-in-a-life-time buying opportunity for those prescient enough to see into the next takeoff.


But, then, if the market has bottomed and the upswing is so certain, why isn’t every investor buying?


Financial Cycles and the Reordering of Society


It is easy to fall for the aesthetic gyrations of the stock market. Their stylized cycles make them look natural. They “revert to mean,” as Francis Galton would have it. They oscillate within fairly clear boundaries. Their ups and downs seem almost automatic (at least in retrospect). Their regularities are so neat many are tempted to forget David Hume and extrapolate the past into the future.


And here lies the problem. The long-term cycles of the stock market, no matter how stylized and regular they seem, are not self-generating. They don’t just happen on their own. Each cycle has a reason, and that reason is deeply social and historically unique.


Note that, during the twentieth century, every oscillation from a bear to a bull market was accompanied by a systemic societal transformation:

  • The crisis of 1905–1920 marked the closing of the American Frontier, the shift from robber-baron capitalism to large-scale business enterprise and the beginning of synchronized finance.
  • The crisis of 1928–1948 signaled the end of “unregulated” capitalism and the emergence of large governments and the welfare-warfare state.
  • The crisis of 1968–1981 marked the closing of the Keynesian era, the resumption of worldwide capital flow and the onset of neoliberal globalization.

Furthermore, none of these transformations were “in the cards.” Most observers in the 1900s didn’t expect managerial capitalism to take hold; few in the 1920s anticipated the welfare-warfare state; and not too many in the 1960s predicted neolib-eral regulation. All three transformations involved a complex set of conflicts, their trajectories were all fuzzy, and their outcomes were all but impossible to anticipate.


In other words, underneath the seemingly repetitive long-term patterns of the market lies an open-ended and inherently unpredictable reordering of the entire political economy. Although past bear markets have always given way to long bull runs, these transitions were never automatic. Each and every one of them reflected a profound transformation of the underlying social structure. And in our view, this correspondence still holds. In order for the current crisis to end and a new upswing to begin, something very big has to happen: the social structure must change.


The precise nature of this transformation – assuming it occurs – is likely to re-main opaque until the process is well under way. But one thing seems clear enough. A new upswing means the rekindling of accumulation, and if we are to understand what this upswing might entail, we need to go back to the beginning and start from the entity that matters most: capital.


For more on that issue, stay tuned for the next installment in our series.

This paper and their subsequent analysis which will be posted in their archives should give you lots to think about as we move into the next phase of the crisis.


So should you dump those high quality government bonds to pour all your money into the stock market? Not so fast. According to a new report by the World Bank, Global Economic Prospects, the current global economic crisis has caused a sharp decline in commodity prices and will likely mean less investment, slower growth and fewer exports for developing countries.:


The World Bank has not ruled out the possibility of a global recession but the report says the worst should be over by 2010.

The report comes as hopes for talks to revive the moribund Doha Round of international trade talks evaporated when World Trade Organization head Pascal Lamy cancelled a meeting last weekend of top trade negotiators in Geneva.

Lamy had hoped to the negotiators would be able to work out the many issues hindering a deal to pump billions of dollars into the struggling global economy through lower trade barriers.

The WTO chief announced the cancellation of the meeting saying he would not recall ministers to renew the negotiations until perhaps sometime next year.

“I think it is the prudent thing to do given the gaps we have seen,” said US Ambassador Peter Allgeier said, commenting on the cancellation of the meeting. “We are deeply disappointed we have not reached that stage yet.”

Brazilian Foreign Minister Celso Amorim said he had favored the proposed meeting, but admitted that such a gathering would be to gain clarity of each other’s positions, and not to hammer out a comprehensive deal.

The financial crisis that has ravaged markets in the world’s more developed countries is now slamming lesser developed hitting developing countries hard.

Over the past month, the World Bank has said it will dole out $14 billion to India over the next three years to facilitate infrastructure development projects and to achieve the Millennium Development Goals. The Bank also said it will join with the Inter-American Development Bank (IDB) to offer about $5.5 billion in loans to Mexico in 2009 to help finance infrastructure, development and anti-poverty programs.

The IDB will inject as much as $2.5 billion into the Mexican deal, with another $1 billion possible.

World Bank analyst Hans Timmer said countries that performed strongly last year are seeing record declines.

"Our forecast is for four-and-a-half percent growth in the developing world, that still seems high but that is more than three percent lower than in 2007, and that is one of the sharpest declines in growth on record," Timmer said.

The decline is blamed on weaker demand from developed countries. That has resulted in a slump in global trade, the first in 25 years. Less trade means losses in manufacturing and export markets, which in turn, have led to growing unemployment.

“The financial crisis is likely to result in the most serious recession since the Great Depression,” said Justin Lin, its chief economist.

"Slower growth means also slower income growth for everybody in developing countries, including the poor, and higher rates of unemployment in developing countries," he said. "That means that the benefits that we have seen over the last five, six years with record growth in developing countries will be on hold for a short period of time."

The report says developing countries in sub-Saharan Africa will enjoy faster economic expansion than most industrialized countries next year. But many countries in Africa and East Asia will face difficulties raising money as credit tightens around the world.

"Things are moving quite rapidly in the wrong direction," Bernard Hoekman, director of the international trade department at the World Bank, said in a recent speech to the Washington International Trade Association. Bank economist Andrew Burns says countries that rely on profits from oil and metals will fare better.

"The positive story there is that when we observe what commodities exporting countries have done over the last 20 years, they've been much more prudent in terms of the management of the windfall revenues they've received as compared with the 1990's and 1980's," said Burns.

Although the recent decline in oil prices has resulted in lower energy and food costs, Burns says poor countries will need help from rich countries to survive the economic fallout.

In an environment of slowing global growth, I would expect government bonds to continue to perform well. In fact, if all goes well, both bonds and stocks might perform decently in 2009.


But if deflation rears its ugly head in the United Kingdom, China and elsewhere, then those low yielding government bonds will look great to all investors.


The threat of deflation is why global interest rates are heading to zero and why governments across the industrialized world are injecting billions in fiscal stimulus programs. It was all about deleveraging in 2008 and in 2009, it will be all about macro risks:

While many people are relatively optimistic about the outlook for financial markets in 2009, the new year is expected to begin much like 2008 ended. Some low-risk market segments have shown signs of stabilization, but illiquid asset classes and those closely linked to the macro economy remain stressed.

Barclays Capital portfolio strategist Barry Knapp sees two primary sources of risk for capital markets: illiquidity related to weak financial balance sheets (deleveraging) and the credit risk associated with deteriorating macro fundamentals.

“As the deleveraging cycle runs its course, we believe the risks for equities are evolving and stocks will likely be viewed primarily as a warrant on an economic recovery in 2009,” he told clients. In other words, while it was deleveraged that drove the S&P 500 down to 750 in the fall, macro risks are expected to be the dominant factor next year.

Mr. Knapp remains cautious as a result, highlighting his expectations for growth and corporate earnings to continue to fall during the first half of 2009. He favours high-quality fixed-income assets over equities and sees a better entry point for U.S. equities near the end of the first quarter.
Macro risks will also weigh on currencies in 2009 and this will impact the performance of many pension funds exposed to illiquid asset classes and hedge funds.

Finally, please take the time to read an article by professors Peter Brown and Geofrey Garver, Don't fix the economy - change it:

Investments in new "green" technology need to be coupled to a regulatory structure that ensures that efficiency does not result in more impact, along with massive investment in creating or restoring natural systems that build bioproductivity.

Economic policy must promote not more affluence as currently defined, but more sufficiency for all Canadians – so that all may live with self-respect, without overconsumption.

Perhaps most difficult to come to grips with is that Canada is an overpopulated country – if you compare the individual impact of each Canadian with what the Earth can withstand. We should escape from the current treadmill that considers more people necessary for more growth.

Lastly, we must greatly increase investment in educational and civic institutions that teach that we are not "consumers," but citizens of the Earth, and guardians of life's prospect on a small, beautiful and finite planet.
I think it is high time we think about our collective actions not just in finance but in the realm of consumption and production and how it is impacting our global ecological system.

The new paradigm of growth will not promote growth at any cost, but will ensure that we are growing intelligently, with a long-term perspective on meeting our future energy needs with clean energy sources.

I end my Outlook 2009 by looking beyond the 2008 stock market crash and sharing with you stocks that are on my radar screen for 2009.

Once again, have a Healthy & Happy New Year. I wish you and your families all the best for 2009.

***Stocks to Watch for 2009 (Will be updated)***

Solar sector: I have written extensively on the solar sector in my blog and this is where all my long-term money is invested. You can read my last comment on solars by clicking here.

The stocks I track are not only the leaders like First Solar Inc. (FSLR), Sunpower (SPWRA), Q-Cells (QCE.DE), MEMC Electronic Materials Inc. (WFR), but smaller players like Yingli Green (YGE), Solarfun Power Holdings Co. Ltd. (SOLF), Renesola (SOL), JA Solar Holdings Co. Ltd. (JASO), LDK Solar (LDK), China Development Group Corporation (CDTC), Canadian Solar Inc. (CSIQ), Suntech Power Holdings Co. (STP), Energy Conversion Devices (ENER), Evergreen Solar Inc. (ESLR), Trina Solar Inc. (TSL), GT Solar International, Inc (SOLR), Timminco (TIM.TO) and 5N Plus (VNP.TO). The ETF for solars is the Claymore/MAC Global Solar Energy (TAN).

Another company getting into the solar panel manufacturing is Jabil Circuits (JBL). Applied Materials (AMAT) is another key player in this field that is worth tracking.

Infrastructure sector: This is another long-term sector that is worth investing in. Apart from the heavy construction stocks, I also like companies like KBR Inc. (KBR) and Canada's SNC-Lavalin Group (SNC.TO). An astute money manager told me to invest in water through the PowerShares Water Resources (PHO).

Healthcare and biotech sector: This is another sector I have written on in the past. It touches on demographic themes that will impact the developed world and there are a few biotech ETFs to choose from (individual stock selection is a lot harder for biotechs).

In the big pharma names, I track Novartis (NVS), Pfizer (PFE), Johnson and Johnson (JNJ) and Merk (MRK). A smaller pharma I really like is Forest Labs (FRX).

In the HMO sector, keep an eye on Cigna (CI) and Humana (HUM) but remember the U.S. government will regulate this sector. Finally, in the medical equipment sector, companies like Charles River (CRL), St-Jude Medical (STJ) and Beckman Coulter (BEC) are worth tracking.

Technology sector: Most analysts like Apple Inc. (AAPL) but my radar is on Research in Motion (RIMM) in 2009. RIMM got slaughtered in 2008 and I think they will emerge a stronger company and compete with Apple in the all important consumer sector. Another sector I like in tech is storage. Companies like EMC Corp (EMC) and Network Appliances (NTAP) should do well in 2009 and thereafter.

Moreover, expect companies to upgrade their IT in a slowdown as they look to become more productive. Companies like Sun Microsystems (JAVA), which also got slaughtered in 2008, should capitalize if business investment picks up pace in 2009.

In software and IT space, I also like Adobe Systems (ADBE), Computer Sciences (CST), Citrix Systems (CTXS), Symantec (SYMC) and Microsoft (MSFT) because it is sitting on huge cash reserves. IBM (IBM) is another titan that is well placed to benefit from business spending. German enterprise application software maker SAP (SAP) is also worth looking at these levels.

In the semiconductor space, keep an eye on leaders like Intel (INTC), Broadcom (BCRM), and Taiwan Semiconductor (TSM) as well as smaller players like Marvell Technology Group (MRVL), ON Semiconductor (ONNN), PMC-Sierra (PMCS) and Flextronics (FLEX). If you want to punt on a penny stock, take a look at Vitesse Semiconductor (VTSS.PK).

In communication equipment space, I like Cisco Systems (CSCO), Harris Corp (HRS), Qualcomm (QCOM) and I am tracking Brocade Communication Systems (BRCD), Cienna (CIEN), Corning (GLW) and Texas Instruments (TXN) very closely. I have all but given up hope for Nortel Networks (NT) and even JDS Uniphase (JDSU) but they are on my watch list (don't ask me why!).

In the wireless space, keep an eye on Clearwire (CLWR), Novatel Wireless (NVTL) Sierra Wireless (SWIR) and Canada's Wi-Lan (WIN.TO) for a more speculative long-term play.

Recession stocks: In an economic slowdown, consumers will look at cutting costs. Companies like Costco (COST) and Priceline.com (PCLN) are on my radar. People are also trying to pay down debt by auctioning off things they own, so keep an eye on Ebay (EBAY).

In this recession, unemployment might peak at 9% in the United States and some think it could get worse. Unemployment will keep climbing across the world in 2009. Given this global weakness, keep an eye on Monster Worldwide Inc. (MWW) as its revenues are expected to grow strongly as millions of people search for work.

Others see value in small caps which typically lead the way out of a recession. One way to invest in small caps is through the iSahres Russell 2000 ETF (IWM).

However, in a tough economic environment, I prefer the big conglomerates like 3M Inc. (MMM) and Textron (TXT) because they are well diversified in many industries.

Finally, one famous New Year's resolution is to lose weight. Have you noticed all those commercials for Nutrisystems (NTRI) on television? Then again, if you love ketchup on your fries, warm soup, or packaged food, then buy Heinz (HNZ), Campbell Soup (CPB) and ConAgra Foods (CAG). And don't forget to wash the dishes and brush your teeth (CL).

In a recession, think lean and mean and think consumer staples. I will be back to update this last section over the weekend.

***Updates***

Global stocks: Some of the worst deleveraging hit emerging markets. Last February analysts were bullish on South Korea stocks, but they were wrong (again!). But now is a good time to start tracking the South Korean stock index ETF (EWY).

In China, research analyst David Sterman revealed his top three China stock picks for the year ahead: Sohu.com (SOHU), Focus Media (FMCN) and China Mobile (CHL). Some analysts are recommending Baidu.com (BIDU) but I prefer Sina Corporation (SINA) at these levels. Another Chinese company I am keeping an eye on is China Medical Technologies (CMED).

Latin American and Russian shares got clobbered in 2008 as commodities and oil sank. If you want to invest in Latin America, look at the iShares S&P Latin America 40 Index (ILF) but I wouldn't pull the trigger too soon (read below).

Oil & gas, commodities and geopolitical risks: Most analysts expect the demand for commodities to fall as the global downturn continues to weigh heavily on resources.

Oil is the big wild card in 2009 as tensions are escalating in the Middle East now that Israel has launched a ground attack on Gaza. One professor wrote me the following:

Let me supply you with the following (improbable??) scenario:

1. Hamas gets painfully beaten in Gaza.

2. Hezbollah come to their aid by firing Iranian long-range rockets from Lebanon.

3. One or more rockets hit the Israeli nuclear installations at Dimona.

4. Israel retaliates by bombing nuclear installations in Iran.

5. Iran threatens navigation in the Straits of Hormuz.

6. Oil goes to $200

I replied that if Israel goes to war with Iran, then all hell will break loose and oil will skyrocket, pretty much ensuring a global depression.

All this to say that despite global economic weakness, oil might make a comeback in 2009 due to geopolitical concerns so keep an eye on oil giants BP (BP), Exxon (XOM), and Halliburton (HAL), but also smaller players like Baker Hughes International (BHI), BJ Services (BJS), GMX Resources (GMXR), Gulfmark Offshore (GLF), Pride International (PDE), Mexco Energy (MXC), Qwest Energy Partners (QELP), and Semgroup Energy Partners (SGLP).

Among the Canadian oil & gas companies, keep an eye on Enbridge (ENB), Encana (ECA), Petro Canada (PCA.TO), and Canadian Natural Resources (CNQ).

All that glitters is gold: Peter Hodson, a senior portfolio manager at Sprott Asset Management, wrote an article this weekend recommending that you sell stocks short and buy gold to survive the Depression of 2009:

Going into 2009, we believe shorting will continue to be a prudent investment strategy.

In a depression, corporate earnings fall off a cliff. Corporate survival can become tenuous, as debts that were incurred during more prosperous times become increasingly onerous. Financing can be very hard to come by, oftentimes being extremely dilutive to existing shareholders.

Although current market valuations may seem reasonable by most measures, they have yet to fall below reasonable. In a depression, stocks will become downright "cheap," and still get cheaper.

Going into 2009, there is definitely further downside risk in the stock markets. Shorting will continue to be an effective strategy to offset this risk.

Next, let's look at the U. S. dollar and U. S. government bonds, also winners in 2008. But will this continue to be the case in 2009? We doubt it.

For one thing, with zero percent interest rates, the upside for Treasuries is effectively nonexistent. They should perform no better than cash, and potentially worse. Treasuries have become the opposite of cheap -- they are downright expensive.

We continue to believe that the strength in the U. S. dollar throughout most of 2008 was devoid of any fundamental basis. The U. S. dollar has been a beneficiary of the massive deleveraging that has occurred as the 2008 financial crisis unfolded. However, very aggressive measures, both monetary and fiscal, currently being employed will severely put into question the notion of the U. S. dollar as a "safe haven" store of value.

With a US$400-billion budget deficit in the first two months of the 2009 fiscal year (started October), the U. S. government is well on its way to posting a US$1-trillion deficit this year, more than double any deficit in history and the largest deficit as a percentage of GDP ever.

Furthermore, in its desperate attempts to reflate the financial system, the ultra-aggressive policies and programs of the Federal Reserve (to date the most aggressive central bank in the world) also promise to ultimately debase the dollar as a store of value.

At a zero fed funds rate and quantitative easing now in full force, what's next? The Fed may soon be the buyer of last resort for commercial real estate, or common equities. The long-held rule that the Fed is only to deal in the highest quality and most liquid securities has been thrown out the window. Although they may be justified in breaking the rules, the rules have been there for a reason; namely, to maintain a sound and stable currency that people can trust.

When central banks start breaking the rules, look out. There are always trade-offs and unintended consequences. Hyperinflation could be around the corner.

Don't let the dollar's status as the world's reserve currency lull you into believing that it couldn't happen here. Any fiat currency is only as good as the faith people have in its central bank. In 2009, we believe this faith will be severely tested, especially in a depression scenario where the desire for competitive debasement may be too tempting to resist.

Lastly, there is gold. Having started 2008 at US$800, gold is now US$840. In other currencies, gold has performed even better. Although there may be some who are disappointed that gold hasn't performed better still, by now there can be no question that in the midst of the 2008 global financial crisis, gold has done exactly what it was supposed to do -- namely, protect portfolios against the carnage that was experienced in almost all financial assets around the world.

Gold has proven itself to be one of the very few safe harbour assets of 2008. Going into the depression of 2009, gold may well be the only safe harbour asset.

No doubt that some are using any bear market rally to start shorting the stock market. But while some perma-bears like Robert Prechter keep growling, others like Bill Fleckenstein have decided to close their short-only hedge funds. Shorting stocks will be much tougher in 2009 and short sellers will get squeezed hard during the bear market rallies.

As for gold shares, heightened geopolitical risks will surely boost gold prices in the near term. You can invest in shares of individual companies like Newmont Mining (NEM), Barrick Gold (ABX), Anglo Gold Ashanti (AU), Gold Fields (GFI) or just buy the SPDR Gold Shares (GLD). I warn you, however, gold is volatile and unless you're an expert in bullion, I would to stay away from junior miners.

Interestingly, gold might prove to be the only safe harbor asset in both a deflationary or inflationary environment.

Financials and Insurance: You will notice that I did not recommend any financials or insurance companies. I am bearish on financial stocks given all that toxic debt on their books and as far as insurance, some of my friends are buying Manulife Financial (MFC.TO) but I am not tempted to buy any stocks in this sector. I prefer to wait till after 2010 to take a serious look at financials again.


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