The Ongoing Credit Crunch Adds
Insult to Injury for U.S. Consumers
Today's comment is by Eric Roseman, Investment Director and editor of Commodity Trend Alert.
Dear A-Letter Reader,
Treasury bond yields are sitting at a two-year low. Housing prices are deflating at an alarming rate. Employment growth is peaking. And the banking industry is suffering its worst bear market since the Savings & Loans crisis in 1991.
The bull market for stocks, which began in late 2002, is now facing its toughest challenge in more than seven years. The tidal wave of bearish developments has grabbed this bull by its horns since July.
But just because this stock bull market is winding down, it's still not quite out yet. Stocks will continue to offer some of the best inflation-adjusted returns over the next 12 months. You can look forward to a decent stock year amid lower interest rates and generally strong non-financial sector corporate earnings, especially overseas. The rising weight of housing deflation, soaring energy prices and the relentless tidal-wave of sub-prime credit losses will subdue the consumer in 2008.
Why U.S. Consumers Still Matter
Housing, employment growth and consumption are the main threats to U.S. and therefore global economic growth in 2008.
Consumer spending in the United States represents approximately 75% of GDP, or gross domestic product.
And make no mistake about it - American consumption continues to drive global economic growth. The rapid ascent of emerging markets this decade and the boom in consumption in places like China and Russia, won't replace the loss in U.S. demand for imports. If the U.S. consumer hibernates next year, foreign economies will feel the brunt of slower exports to the world's largest economy.
With employment growth stalling and wages now declining, the grand bull market for the consumer is about to slow, and possibly, contract. Indeed, imports have slowed this year while U.S. exports are rising as a cheap dollar continues to make American goods extremely competitive abroad at the expense of soaring foreign currencies.
Housing Deflation a Major Threat
In addition to discretionary spending, housing is also a major player driving U.S. economic growth. According to some measures, the bear market in residential real estate is now the worst since the Great Depression.
September was a watershed in the housing industry. Builders cut housing starts to a decade-low of 1.19 million units while 4.4 million homes remain unsold - 16% more than a just 12 months ago. Housing deflation, or a period of protracted price declines, is the single largest threat to U.S. domestic consumption.
Since 2006, the era of reverse mortgages has ended with a thud. Now more homeowners are cutting back on discretionary spending and looking to the stock-market as their wealth savior.
The credit crunch is just adding insult to injury for homeowners.
Mortgage Resets a Major Hurdle in 2008
My colleague Mike Burnick has been closely following each twist and turn of the U.S. sub-prime credit crunch, and I'm convinced it may get even worse next year. With banks and investment brokers saddled with several hundred billion dollar's worth of mortgage-backed losses that continue to mount by the week, the credit crunch is not about to end anytime soon.
The housing market will face another enormous test next year when over US$500 billion of mortgage resets come due at higher interest rates. If employment growth continues to stall, housing values deteriorate further and the stock market declines, it's hard to imagine the consumer holding up without more credit delinquencies and defaults.
Remember Japan?
Previous banking crises worldwide over the last 30 years usually morphed into greater losses following the initial shock or blow. This was the case with Latin America's debt crisis in the 1980s, Japan in the 1990s and the S&L crisis starting in 1989. Each episode resulted in far greater losses for investors as banks only grudgingly revealed the extent of financial bleeding.
Just how bad is the current sub-prime crisis affecting the U.S. economy and money-center banks? Almost daily, one institution after the next is dropping a financial bomb on shareholders. And there are likely to be many more financial market shocks to come in 2008.
Markets are unsettled because the majority of these companies seemingly can't clean their books. Considering financial services represent a nearly 20% of the S&P 500 Index's total stock-market capitalization, it's pretty amazing that stocks are in positive territory at all in 2007, and even hit new highs earlier in October.
Stick with Global Stocks, but Get Defensive
The Federal Reserve will cut interest rates aggressively into 2008 to boost the economy in a Presidential election year.
Money-supply growth worldwide remains buoyant, supporting equities and most commodities. Interest rates in Europe will decline over the next several months to give those economies a lift.
But risk is rising. The threat of deflation, not inflation, is my primary concern as the enormous weight of housing continues to impact U.S. consumption and ultimately, economic growth in 2008. With employment trends now looking weak combined with high energy prices and no end in sight for housing woes, the consumer faces his biggest test since 1990-1991.
I'm still invested in global stocks (only large-caps), commodities, foreign currencies and increasingly, cash. Also, I'm not adding to stocks at these levels with the exception of hedged products that can mitigate market risk and earn profits in a bear market.
In 2008, asset allocation will determine whether investors earn a profit or lose their shirt in an increasingly fragile bull market.
ERIC ROSEMAN, Investment Director
P.S. My colleague Mike Burnick is busy putting the finishing touches on a special alert audio briefing that takes place tomorrow at NOON EST! Mike's new service, Market Shock Trader, has consistently racked up big gains during the first phase of the Wall Street credit-crunch this year. In his special audio briefing tomorrow, he'll review the sub-prime mess, and give you his updated forecast on how to play the next phase of this market shock. This special audio briefing is FREE, but space is limited, so you must RSVP by MIDNIGHT tonight to reserve your spot.
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