I like to approach the financial world with a thesis, an idea, at least in broad terms, about how things will play out, now and in the longer terms. I’ve tried to be clear about that in posts here, as well as elsewhere.
Generally speaking, my current 25,000-foot view is this:
- We are going through a credit crisis sparked by the subprime meltdown. It is broader than that, however, really the tail end of an orgy of leverage and credit creation dating back at least 15 years
- The unwinding of all this credit bubble will take longer than most people expect, and the damage will continue to be broader than most expect. Beyond banks and financial institutions, it will include many municipalities, some large-cap tech names reliant on major debt-financed network buildouts, a host of debt-financed non-financial companies, and some sovereign nations. Total cost: Bridgewater’s $2.7-trillion looks close enough to me .
- S&P forward-year earnings forecasts will come down faster than at any time in recent history. We will see 20% average estimate reductions across the board, leading to a further revaluation of the markets. After all, at S&P 1010 we are trading at 19x trailing earnings, and 18x forward, neither of which are inexpensive historically speaking. Admittedly, the above is not the non-financial S&P P/E — ex- financial and consumer stocks we are more like 14x — but it is a distinction that will get blurred as we go into this recession.
- We are already in a recession that will last well into the the fourth quarter of next year.
- Unemployment may touch 9% in the U.S. at trough.
- Obama will win the U.S. presidency.
- Housing will fall 10-15% further in U.S., and we are only beginning major declines in Canada, U.K., Australia, and elsewhere.
- U.S. consumers will become much more aggressive savers, both through debt reduction and direct saving. Similarly, future fiscal stimulus will largely be saved in service of this overdue need to fix domestic balance sheets.
- U.S. long yields have to rise, making curve steepener trades feel appropriate.
- Commodities will stay under pressure for the next two years,and then reverse savagely as developed countries emerge from recession at very similar times. We have newly resynchronized the global economies, which will have immense consequences.
- Coming out the other side, we will see a barbell economy, with growth and investor interest at the mega-cap consolidator end, and at the entrepreneurial smaller end. The latter will be driven by major developments in clean technology, in particular, which was just given a two-year window to gestate before the major economies worldwide turn higher and begin driving energy prices straight up.
There are just a few of the components of my economic worldview. While I’m skeptical we can hold current levels, I’m also a pragmatist not an ideologue. In other words, I’m not wedded to this view, and so I’m happily proven wrong if layoffs are less than expected, economic growth rebounds sooner, major growth prospects arise, etc. I will change tacks immediately.
So why do this? Because it is important to be falsifiable, to know what things would convince me I’m wrong, whether too optimistic or too pessimistic. As J.B.S. Haldane reputedly said when asked what would convince him his take on evolution was incorrect, "Fossil rabbits in the precambrian". These are just some of the rabbits I’m watching for, one way or the other.
Feel free to add others.