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End-of-year outlook for 2008 mostly on the money – what's next?

Stockhouse community member Matt Stiles, also known as StilesBC, has returned with a multi-part series that offers a look back at market behavior for the first six months of 2008. These articles are follow-ups to his December/January series of new year predictions called “Themes for 2008.” To read what Matt said then, check out the following links:

Themes for 2008, part one
Themes for 2008, part two
Themes for 2008, part three
Themes for 2008, part four
Themes for 2008, part five

It is a rare treat when commentators take the effort to go through past picks and predictions to see what they got right – or wrong – and then let their readers know. The courage to own up to mistakes and celebrate wins is the hallmark of a trustworthy market watcher.

Please enjoy part I of Matt Stiles’ analysis below, “A look back,” and stay tuned for more in the coming days.

A look back

With half the year behind us, the rollercoaster ride that are world asset markets have definitely given many cause to stop and think. Sadly, many of my more dire forecasts have come to pass. Shortly after writing my end of year marathon article over Christmas, equity markets worldwide went in the tank. Conversely, commodity markets have skyrocketed. And despite a spring rally off the March lows, many equity markets are hitting new closing lows for the week ending Jun 27. It has now become obvious to most that the imbalances many have been harping on for years have finally come home to roost. And they aren't going away. Without further ado let's take a look at last year's predictions:

- U.S. economy is either currently in a recession now (Q4 ‘07) or will be in one early in 2008.
- The Canadian economy will follow
- Emerging markets will experience slowdowns as the U.S. consumer is pinched
- The credit crisis will continue to intensify as more homeowners go underwater on their mortgages
- Commercial real estate declines, credit card defaults, and bank runs will be major stories in 2008
- Municipalities and states will be going bankrupt and require federal bailouts
- This situation will be a catalyst for the precious metals complex and could push gold past $1000
- There will be a time for both large declines and large gains for the US dollar - likely in that order
- The Federal Reserve will be seen at some point in 2008 as “an emperor without clothes”
- U.S. stocks will decline as lower interest rates fail to revive the credit markets
- Energy and food prices will continue their upward climb due to supply concerns

I'm not the "I told you so" type, so I'll try to take a more critical view of these last six months. Much of what I expected to happen did in fact happen. However, the dollar's bounce was definitely weaker than I had expected (something I will expound more on later). I was also caught off guard on the precious metals' relative underperformance to crude oil. And perhaps I shouldn't be surprised by this anymore, but the lengths central bankers and politicians were willing to go to manipulate the markets in their favor have surpassed even my lofty expectations.

If the first half of the year was so wild, the second half promises to be just as much so. With presidential elections occurring in the U.S., the Beijing Olympics, a rekindling of war rhetoric toward Iran, and the weakening economy, it's not too late to reposition your investments for what is likely (or unlikely) to come.

It is easy to extrapolate what has occurred through the last six months over the rest of the year. Just like it is easy for the most well-paid economists to rely on a “second-half recovery.” (Sidenote to referenced economists: The second half starts this week.) So I will attempt to take a more constructive view of matters and hopefully find some truth behind the obfuscation, misrepresentation and outright lies perpetuated by most of the mainstream media.

In doing so, I will offer my usual caveat. With hindsight, some of my thoughts will be way off base. Some of them will be way too early. And hopefully, most will enable myself and my readers to accomplish what they hope to: Better than average returns on their investments.

I stress “better than average” because in a bear market those chasing large returns will likely end up in tears. Now, more than ever, is the Wall Street axiom “bulls and bears make money, pigs get slaughtered” most applicable. With high volatility becoming the norm rather than the exception, it is easy to let the allure of quick profit stand in the way of time honored investing principles such as:

- Reduce and avoid all debt – including leverage
- Keep positive savings at the expense of a higher standard of living (i.e., live within or below your means)
- Diversify your asset base
- Expect the unexpected – job loss, societal acrimony

Those are just a few of the widely accepted ways to ensure you come out on top once this all blows over. Yet it is not something I see many people taking seriously. In fact, of the few people I know who do understand this, my octogenarian grandfather knows best. Perhaps growing up during the Great Depression is the root of this. It aligns perfectly with the logic William Strauss and Neil Howe extolled in their '97 book The Fourth Turning. Human expectations usually only encompass the range of occurrences throughout their lifetime.

What this means is that anyone under the age of 85 has not experienced deflation in their adulthood. All they have known is that the best way to get ahead is to go as far into debt as possible, use that “free” money to buy assets, and after 10 years they'll be further ahead than when they started. Wash, rinse, repeat, and you'll be rich! It also means that for anyone under the age of 45, stories of a 16 year bear market in equities (1966-1982 inflation adjusted) are just that: Stories. Their perception is that markets go up over time and that if you buy the dips, you'll be rewarded. But what happens when recent historical trends are broken? What happens, for example, when complex mathematical models fail that are supposed to determine a certain occurrence to be 99.95% unlikely to occur over one year? What happens when they fail three times in one week?

My intention is not to out-bear the bears, but to provide possible outcomes for both sides of the coin. One side of that coin tells me that it is very possible for a multi-decade depression to occur in western economies. This is consistent with generational cycles (see: Strauss and Howe) and the much respected Kondratieff cycle. Until proven wrong, these theories are in play. The societal impact this would have is unnerving. Previous depressions have never been resolved without terrible loss of life. This is one potential outcome among many. There is much that can be done to prevent the worst case scenario. And I'll touch on that later. But keep in mind that cycles are circular for a reason. Just because we are entering an economic/demographic winter does not mean spring will never come.

Together, I hope that my readers and I can prepare for what is to come in the short term, and thereby position ourselves to have a head start when spring arrives. In the following installments I'll touch upon the equity, currency and commodity markets.

 
ABOUT THE AUTHOR
Matt Stiles

Matt Stiles is a 25 year old self-proclaimed economist hailing from Vancouver, Canada. His interest in economics was spurred after traveling the globe and noticing that the financial behavioral preferences of other cultures did not match those of his own. Every day since has been spent uncovering stones in an attempt to reconcile this disconnect. His writing is part of that fact-finding mission, and it is a way for him to learn about himself and others through feedback.  Matt has traveled to 20 countries in 5 continents, speaks German as a second language and is currently struggling with Spanish. Other interests include following his favorite sports teams (Canucks and Angels), politics and above all, time with friends and family. He is currently living in South America.

 
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Comments
Well, can't say I haven't heard of that strategy before. Essentially, buying gold on margin (which you can do with a commodities broker anyway). But there are other risks involved. As you say, I have a deflationary bias. So the fact that gold may outperform other assets doesn't neccessarily imply it will outperform nominally - so the rate of interest could beat you. Depending on the contract, you could also get a margin call of sorts, where the banks simply asks for it's money back immediately. If the price of gold happens to be below what you paid for it originally, you're screwed. As part of a larger strategy where holding savings in other (perhaps offshore) accounts, it may be feasable. Otherwise "borrower beware".
I have a question Matt - but I think I already know the answer. Have you seen Gabe's link with the info about "shorting" the dollar through a home equity LOC (in an inflationary environment)? I don't have the author's name on hand, but I'll get it. The strategy is to go long hard assets (in the example given it was gold and real estate) while at the same time shorting the dollar through an 80/20 loan/value LOC secured at a low long-term interest rate and then sit back and watch as inflation "shreds" the debt-load and pumps the gold - and if you're lucky to boot, the real estate appreciates at the inflation rate. Obviously, this presumes an inflationary bias - from what I read here you're on the deflationist side, which accounts for your advice to "Reduce and avoid all debt." Rob
I encourage readers to comment and ask questions. I learn via hearing other's opinions that are contrary to my own. Regards, Matt
 
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