The past year has been sobering for taxpayers, retail investors and fund managers, what with severe declines in housing, mortgages, banking, stock markets, commodities, retail, automotive, shipping industry, etc. The extreme volatility in 2008 may be over but more of the same challenges await us.
Personally, I have made a new year’s resolution to be a more careful reader of financial reports, and by that, I mean reading with an inquisitive mind. Of course, if a management wants to get creative with their financial statements and the auditors are in a collusive mood (remember, the person who pays the piper calls the tune), our money is fair game for the predators.
That said, we should still do our part in poring over the footnotes. A lot of information can be gleaned from the fine print - an innocuous sentence (like lease arrangements) can make a huge difference to assets/liabilities, and cash flow when in fact the company’s prospects have not changed fundamentally.
Another new year’s resolution is to avoid taking unnecessary risks. Sure, a lot of stocks are now near their all-time lows and in terms of price-to-earnings ratio, there is a strong upside potential once the stock market recovers. Nevertheless, I prefer to cherry pick with moderation. While I continue to average down my investments, I frown upon the use of debts or jeopardizing retirement accounts to chase higher returns.
Some analysts expect a wave of optimism to sweep global stock markets before Obama’s inauguration on the 20th. However, this rally will be more for the short term traders who have their exit strategy ready when the momentum dies out.
Overall, I still maintain a gloomy outlook in 2009. Deflation will continue to be the main theme but we may get a whiff of inflation later in the year. Some of the likely scenarios in 2009 are:
1. More bank losses and failures
As businesses cut expenses to cope with the recession, retrenchments will begin in earnest in 2009. The loss of income will have a dire effect on property prices as people default on their loans or are forced to sell their houses below cost. We can expect banks to report increasing non-performing loans.
Not to forget, delinquencies on credit card debts and auto loans which will further weaken the banks’ balance sheets. Credit card write-downs had already increased significantly and if a behemoth like American Express is severely impaired, other banks will not be having a good time either.
2. Commercial Properties Hit Badly
Bargains and discounts fail to prevent US stores from experiencing their worst holiday sales since 2003. This confirms a severe contraction in demand as consumers become more careful with their cash. Frugality is the new craze sweeping America as many people feel poorer with a sharp decline in their assets and lay-offs.
Amid the bleak business outlook, retailers may have to negotiate for lower leases or be forced to close shop. The earnings of commercial properties are expected to suffer. Managers of commercial REITs will have to work extremely hard to maintain the same results in previous years.
3. Burst of the Treasury bubble
Just a few weeks ago, US Treasury bills trade at negative interest rates. This means that investors have to pay money to provide loans to the US government. Some banks are also using bailout money to purchase US treasuries yielding less than 1%, rather than lending to consumers and businesses at 4-8%.
Don’t make financial sense… but when fear and panic hold sway, anything is possible.
For those who bought 30 year Treasury bonds, they willingly accept 3% interest rate. If inflation is kept at a low 1-2%, a positive real return is possible but over a period of 30 years and with the money printing machines working full-time, inflation will definitely be back with a vengeance and thrash this pathetic return.
In addition, the Federal Reserve is toying with the idea of buying back some of the Treasury bills, so as to inject even more liquidity into the system. This will put upward pressures on T-bills prices while driving down long-term interest rates.
Investors who bought the Treasuries at a high price will suffer a huge loss in face value when inflation and a resurgent stock market return.
5. Crude Oil To Reach $75
I have enjoyed watching crude oil prices fall to its low of $36 and the pump stations adjusting their rates. I will be even happier if crude oil falls to the mid-$20’s, as it will provide further relief to my car expenses and utility bills. Nevertheless, it is not realistic, deep recession or not.
The lowest price of extracting oil is about $30 per barrel (that is for Saudi Arabia, many other oil producing countries have higher break-even cost) and I do not believe oil companies are so charitable that they foot the shortfall out of their own pockets to drill the oil for us.
Oil prices will not rush back to $150 though unless global demand returns and that is not likely to happen soon. An equilibrium price may be the $75-$100 region in 2009. In the long term, write off $200 oil at your own peril.
6. Go Long On Gold
Gold may scale $930 per oz by January 2009. Since hitting a high of $1032.80/oz in March 2008, gold has tumbled by more than 33% to mark a low of $681/oz in October 2008. A recovery in the US dollar, fall in physical demand, collapse in oil prices and liquidation to meet margin calls were to blame for the plunge.
However, gold is expected to bounce back and regain its safe haven status, especially with geopolitical tensions mounting (India vs Pakistan and Israel vs Palestine). The financial crisis and recession are not over yet, and with central banks injecting so much money into the financial system, debasement of currencies will definitely occur.
Gold will become more attractive as a hedge against the dwindling purchasing power and the loss of faith and confidence in paper currencies. At the moment, gold is undervalued and will be a good addition to your portfolio before it gets too expensive.
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