Thesis Update and Factors I’m Watching

The following is a summary of my Thesis and factors that I will keep an eye out for in the coming months.  
Housing:  I still expect housing to double-dip in price terms.  The expiration of the tax credit should create enough momentum to carry the market throughout the summer, but by the fall (if not sooner) the trend downwards will be evident.  I continue to believe that housing is the crux of the problem and natural market forces will take over once again as the gov’t withdrawals stimulus.  This double-dip will cause a double dip recession for the US economy.  (Keeping An Eye On:  Recent readings from homebuying intentions are increasing the risk for a more muted pop in home sales as the tax credit ends and thus a worse than expected summer season.)
Industrial Production (Manufacturing):  The industrial Bounce will carry for the rest of Q1 and will begin to lose steam in Q2.  Once it is obvious that there is no end demand, factories will once again sit idle and capacity utilization will decline.  (Keeping An Eye On:  Will end demand in the US rebound in time to carry the baton?  Will China tightening result in a false dawn for that recovery and thus the global recovery thesis, or will they indeed have a domestic sector that will carry the economy and help the US export its way out of the recession?)
Service Industry (Non-Manufacturing):  The service industry will grow, but at a very tepid pace.  I believe that along with manufacturing, if there is no end demand, the economy will plunge back into recession which will result in further contraction. (Keeping An Eye On:  Once again, end demand in the US and China.  Will it come back?  This is the 64K question.  I still do not believe so.)
Consumption and Borrowing:   Consumption will grow but at a tepid pace and will not be a sector that will greatly contribute in whatever rebound we are currently in.  High levels of debt (De-leveraging), increases in taxes for the wealthy (Ricardian Equivalence), increasing savings rate as baby boomers find out that they have a big shortfall in their retirement nest eggs, high unemployment, and a renewed downturn in home prices will keep consumption (70% of the US economy) under wraps.  (Keeping An Eye On:  The housing market.  If we have a renewed downturn, you can bet that banks will be under more pain, and this important sector will strangle an economic recovery as credit further contracts.  Another factor I’m looking at is inflation.  If inflation begins to accelerate, we may see increased consumption as household would rather buy something now than wait for their dollars to lose more value.)
Consumer Confidence:   I expect consumer confidence to come back but very slowly.  We may experience a further set back if we have a double-dip recession.  (Keeping An Eye On:  Job creation and the Housing market.  If jobs begin to get created you can bet that confidence will rebound, which will lead to more spending.  Also, if housing prices continue to be supported, then homeowners will be a little more inclined to buy that durable good as they don’t see shrinking equity from their most important asset. )
Jobs:   This is the Key Cog in the whole equation.  I see volatile readings throughout the year.  The Census will probably result in stronger job reports in Q2 (will the market see through this and conclude that these same jobs will be eliminated in a few months?).  Q3 will most likely see job cuts as the Census ends and if end demand doesn’t come back, the economy will contract again which will result in more job losses.  Will Obama’s job stimulus work?  (Keeping An Eye On:  Signs of a resurgence in hiring…I believe that the next 4-6 months is make or break, if we do not see substantial job creation, a key factor in sustainable consumer spending will not be there.  End demand will not appear.)
Inflation:   Another Key Cog.  Due to debt elimination, high capacity utilization, and little bank lending, I expect inflation to remain muted and in fact deflation will continue to grip the economy.  (Keeping An Eye On:  A possible supply-shock from higher commodity prices.  Question is: will firms be able to pass these costs over to consumers?  I don’t believe so, thus a "margin squeeze" will be a 2010 story).
Gov’t Policy:   The Massachusetts election was a big wake up call telling us that the political will for continued bailouts and stimulus packages is not there anymore.  Citizens are more concerned about the massive debt that we are piling up to try to get the economy rolling again.  Because of this, I don’t believe that we will see further purchases of MBS and/or further stimulus in the near-term.  However, I do believe that the will change once we fall into a double-dip.  The banks though will not be spared this time though.  Any bank that experiences problems will be nationalized instead. (Keeping An Eye On:  The mid-term elections.)
US Dollar:   Am looking at a rally lasting most of 2010 as risk aversion returns and sovereign problems abound.  In the land of blind men, the US will continue to be the one-eyed king.  (Keeping An Eye On:  Inflation.  If inflation begins to show signs of coming back, the dollar will fall, that is until the Fed is forced to raise rates to prevent catastrophic hyperinflation.)
S&P and Commodities:  Over the course of 2010 my thesis still calls for a fall in the stock market and commodities in general.  The whole recovery has been built on sand, China will disappoint, and we might undergo a global double dip.  (Keeping An Eye On:  The US consumer, job creation, and inflation.)
Treasury Market:   Even though I have expressed my nervousness, I still believe that Treasury yields will decline as deflation wins out in the end, risk aversion comes back, retirees begin looking for income instead chasing the stock market which has brought terrible results over 10 yrs, and banks continue to repair their balance sheets.  (Keeping An Eye On:  Inflation Inflation Inflation.  If the economy actually begins to recover, rates will move up quickly and Treasuries will sink!!)

My next update will be around April 1st (April Fools Day). We’ll see if the economy and the markets made a fool out of me by then. I am sure that I won’t be right about a multitude of things…however… the debt problem continues and we have come to a point where growing out of the problem is a very high hurdle (too high in my view). The only solution here is for debt elimination. Capitalism must be allowed to work. Bad bets on the part of investors and bondholders must be wiped out. There’s a reason that there are disclosures everywhere regarding investing: NOT FDIC INSURED, NOT GUARANTEED BY THE BANK, AND MAY LOSE VALUE. The gov’t and banks should practice what they preach right?

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