January 23, 2009

More Predictions for 2009

Weekly Snapshot
• Gold price reaches $903 at European market close on Friday
• British Pound versus US$ fell to 1.3500 today during Asian markets; it was the lowest level since 1985
• European governments have so far injected €110bn into the banking sector
• S&P downgraded Portugal's sovereign ranking from AA- to A+
• Royal Bank of Scotland reports GBP 22-28bn losses; UK government buys 70% of RBS
• S&P downgrades Spanish debt ratings
• US housing starts fall to the lowest level since records began in 1959
• Nice graph on US housing starts http://www.calculatedriskblog.com/2009/01/housing-starts-at-all-time-low.html
• Major Central Banks leave rates unchanged

A Note on Financial Markets
Financial markets function (or have been until last summer) because there are typically 2 completely opposing opinions on any tradable asset. This is important because in order for a market to function properly you need buyers and sellers, preferably in more or less equal numbers. Without opposing opinions free markets would not exist and asset prices would be set e.g. by governments as opposed to demand and supply. We may now be entering an era of quasi-fixed asset prices in that various governments have taken stakes in non-government entities and/or have indicated that certain companies (primarily banks and some car manufacturers) will be "bailed out". This is effectively putting a price floor on certain stock values. With regard to the capital injections by governments into some of the financial institutions, we must now look at these stocks the same way we look at utility companies. They are semi-free enterprises but obviously do not have the traditional upside potential of stocks either. And they usually don't go out of business because they are a "utility" for the greater common good of society. We can't do without power/water etc. and in this day and age, we certainly cannot live without a functioning banking sector.

But since some of these banks are now quasi nationalized, we should ask whether it is not more appropriate to demand a true and more meaningful bailout of the taxpayers and consumers. At the moment, banks can borrow money at 0.25% but yet, they lend it out at 5.5% for a 30 year mortgage (rough average this week), if they lend at all. To me this is almost criminal and really calls for a complete elimination of the "middle man" i.e. the bank in between ultimate lender and the consumer. If a bank made poor decisions and took on too much risk, it should deal with the consequences. Instead of bailing out banks, governments should consider lending to the consumers directly. Eliminate the mortgage broker or mortgage bank altogether and give out a mortgage at 4% directly from lender to consumer, but obviously with reasonable down payments say 20% or higher. Personally, I do not endorse socialism nor communism but if some governments have socialist undertakings, they should do it effectively. What the US and some European governments have done is neither free market capitalism nor is it socialism; it's simply showing favors to those sectors and some specific companies who seem to have the highest influence over elected officials. Mr. Obama promised more transparency in government; with regard to the mortgage business and bank bailouts direct lending without the banks brokering deals would not only be more transparent, but also much more cost effective for consumers and less of a financial burden for the taxpayers who ultimately have to foot the bill for all government spending.

On Opposing Views
I'd like to share two very interesting articles with opposing views on the state of the economy.

In his Blog, Carpe Diem, MJ Perry compares a few economic indicators from today with the equivalent numbers in 1980/81.
According to his views, the state of the economy isn't all that bad: http://mjperry.blogspot.com/2009/01/economy-is-bad-but-1982-was-worse.html

Prime Rate: 1981: 20.5% vs. 2009: 3.25% (Current)
Inflation: 1980: 14.8% vs. 2008: 0% (December)
Unemployment Rate: 1982: 10.8% vs. 2008: 7.2% (December)
30-Year Mortgage: 1981: 18.5% vs. 2009: 4.96% (Current)
Real Gas Price (2008 dollars): 1981: $3.45 per gallon vs. 2009: $1.82 (Current)

By contrast, I also recommend that you read a more sober assessment from a young analyst in Dubai. In "Diary of a Bad Year", Jawad Mian gives a completely different view of things to come. Among other things, he shares a compelling rationale for a possible target level of 450 for the S&P500 http://blogs.zawya.com/print/jmian/090111133800/

On Currencies
As noted above, the British Pound fell to its lowest level against the US$ since 1985. It is evident that the financial markets see a greater risk in shouldering the UK's debt problems as opposed to the US government's equally daunting task of stabilizing the markets. Throughout the history of freely floating exchange rates, the British Pound has experienced several fast and violent bear markets. Most notably the two major bear markets in 1991 and 1992 when the Pound crashed from highs of just above $2.0000 to $1.6000 (1991) and again from $2.0000 to $1.4000 (1992) within just a few months. This time around, the crash has been more violent and further yet. Since summer '08, the British Pound had a clear down-trend each month, without significant technical retracement. This also reflects a currency trader's experience in that the British Pound, more than any other major currency, seems to have a stronger gravitational pull. When it falls, it falls fast and hard. And from an historical perspective, the lows of $1.05 established in Feb/Mar 1985 do not seem so far fetched anymore. That seems to be the next target of some currency traders, who continue to be shorting the Pound. To read more, please email:

Good luck & good trading!

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