My Predictions

- A recession is when your neighbor loses his job. A depression is when you lose your job.

Harry S. Truman, in the Observer, April 13, 1958

- A recession is when your neighbor loses his job. A depression is when you lose your job. A recovery is when Jimmy Carter loses his.
Ronald Reagan, during the Presidential Race of 1980

- A recession is a time for the economy to heal from greed and equity bubbles. Fighting and hiding the process leads to a depression. A recovery occurs when the Fed wakes the F up and stops pandering to Wall Street.
- Rocketshoe

Folks, its coming… It looks like 2008 will be the beginning of a recession for the American economy. A lot of folks refuse to acknowledge this, but its knocking on our door. This is not an entirely bad thing—recessions are an opportunity for a return to normalcy, just a part of the business cycle (read more at: http://en.wikipedia.org/wiki/Business_cycle ). If you prepare yourself and your portfolio appropriately, you can protect your investments and even profit from a downturn in the US economy.

A lot of people will not discuss or even admit we will be entering a Recession soon (you know who you are). It has been some time since our economy has been in a recession (generally accepted as two straight quarter of declining GDP). After the great market run-up of the dot com boom/bust , interest rates were cut dramatically which lead to another bubble—the Housing Boom of the last couple of years. Both of these instances were bubbles based on greed, speculation, and virtual valuations of both company profits and property. A recession allows the economy to re-price these investments and assets appropriately to maintain an efficient market where values are in-line with historical norms. Not only are valuations appropriate, but risk is re-priced as well (an ideal market is where one sees greater returns for taking on greater risk).

There are a significant number of indicators and factors that lead me to believe we are entering a recession:

1. The housing market is crashing, hard. Predatory lending coupled with lax lending regulations has lead to folks taking loans on homes that they cannot afford—subprime loans are resetting in force next year-some folks will have their mortgage rates double. Couple this with an increase in supply of newly-built homes, a tightening of who can get loans in the credit market (see: US Economy, circa 3rd quarter, 2007), and home prices WAY above historical norms and growth rates, will lead to the housing bubble popping. An entire part of our economy is built on housing now—mortgage brokers, home improvements, builders, all kinds of retail and labor to support the business. If you don't believe me, listen to any of the 3rd quarter home builder conference calls where they said they have never seen a downturn this bad, or no recovery in the foreseeable future. This is not the end but the first domino to start everything.

2. People will be spending a lot less money on retail, namely ipods, cars, and granite counter tops. ~70% of our economy and GDP is driven by consumer spending. The last few years have been a feeding frenzy for retail goods for folks who refinanced their homes to pull out cash to take advantage of the increased value of their homes. People bought cars, home improvements, vacations, etc. When that mortgage doubles, or folks can’t finance their lifestyles by continuing to flip houses, the party is over and spending will drop significantly. Reduced retail spending will directly hurt our economy.

3. The banks have been bad. Very bad. Enron bad. Investment houses, banks, and hedge funds have been playing games with how they represent debt on their books. Most of this has to do with home loans that were wrapped up into bonds and used as leveraging for borrowing money from each other and the Fed. At one point the liquidity in the market about halted (Think of banks loaning money to each other as a way of putting money in the cash register to make change and do business). Very bad—the Fed stepped in and dumped cheap money into the economy and waived some of the rules regarding how much money banks are required to keep as reserves during normal operations. This should scare the shit out of everyone, because some of these rules went into place after the Great Depression to prevent bank collapses. As these shit bombs are slowly revealed and written off, banks take a hit, and peoples’ investments disappear. It is hard to properly value assets and the stocks of companies, if these bad numbers are not on public books for people to evaluate and price properly. Banks can collapse. You are only insured up to $100k wit the FDIC. See an earlier post about where to stash your money. Some folks say, ‘A major bank will never collapse’. You can’t know with the current shenanigans going on, so why chance it? In conclusion, banks are the blood of our economy, and when they start to bleed out, our economy will suffocate.

4. Earnings are down across the board for American public companies. Most are showing a loss stateside but growing profits overseas. See CAT, and UPS for example. The third quarter was rough for the S&P, besides Tech (which is another discussion entirely), everyone is down—which is a direct indicator of a slowing economy.

5. Inflation is rearing its ugly head. With the recent Fed cuts (and the Fed thinks that rate cuts will improve liquidity and save the economy in the short term), the dollar has dropped like a rock (check out the $ index at: http://quotes.ino.com/chart/?s=NYBOT_DX , This chart measures a weighted value of the US dollar against six currencies: the Euro, Japanese yen, Canadian dollar, British pound, Swedish krona and Swiss franc on a 100 basis. i.e. a value of 90 means a 10% drop in the value of the dollar across the board). Inflation is another beast that will kill consumer spending. Not only will consumer spending be hit, but we run a case of capitol flight risk since foreigners don’t want to buy our debt if the value of their investment is dropping. Then we are screwed when we have to pay our own debt. Higher taxes for everyone!

6. The SEC is on vacation. These guys are supposed to be the cops of the Market. Lately, there have been a lot of shenanigans that have not been investigated—all the false reports of Warren Buffet taking stakes in companies that have hit the news wires, Countrywide not releasing details of funding sources, and my favorite: the front running of the last Fed Rate cut--I got a chart here somewhere I'll post of a stock popping minutes before the announced rate cut. If someone leaked the news from the Fed to ANYONE who profited on the news, they need to go to jail. This kind of horseshit hurts the market in the long term, even if the SEC is on vacation to prevent market volatility in the short run. How can people invest and trust a market that does these things?

Those are a few of the major things I believe that will lead us to a recession. At least I hope we have a recession—this will give us a chance to clean up the mess over the last ten years and get to point where we have a fairly priced market.

Now, how do we profit from the upcoming recession? Many ways are available- investing in secular dividend stocks, foreign stocks (the rest of the world is doing a bit better and not necessarily coupled to our growth) , playing the volatility (the upcoming rate this week is a freebie), shorting stocks that miss their earnings, and playing in the bond market. Stay tuned and be careful.

-Rocketshoe