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Markets: Fallen Eagle?
New York: November 10, 2008
By John R. Stephenson

For a while things looked pretty good. The stock markets rallied for six straight days and America elected Barack Obama as President. But then the October job numbers came out showing a staggering loss of 240,000 jobs. If that weren't enough, the August and September unemployment numbers were revised downward for an additional loss of 179,000 jobs. Since the beginning of the year, America has lost 1.2 million jobs and the unemployment rate has leaped to 6.5%.

The U.S. auto industry has been struggling lately, with October's figures indicating annualized sales of just 10.3 million cars, down from the previous year's figure of 17 million. According to an article in The Financial Times of London , an extra 1.5 million cars have been sold due to cheap financing, rebates and the like. There should be no doubt, that tough times lie ahead for Detroit 's big three automakers. This was further underscored over the past week, with the release of a study from the Center for Automotive Research in Ann Arbor, Michigan which suggested that the U.S. economy could lose an additional 2.46 million jobs over the next year alone if the Detroit car manufacturers cut output and employment by 50 percent. A reduction of 50 percent may be necessary to bring Detroit in line with the anticipated market share for their cars.

The easy money conditions over the last few decades have created an explosion of household debt in America . Today, Americans hold $2.6 trillion of consumer debt in the form of auto loans, credit card debt and bank loans. From 1959 to the end of 2007, household debt, including mortgages, has soared from 47% of personal income to 127%. Wow! Already, retailers are beginning to feel the pinch of slowing sales as consumers, fearful of job losses, start to retrench. Sales at Nordstrom's are down almost 16% this year and at rival J.C. Penny, sales are down 13% on the year.

This trend is unlikely to reverse any time soon, as the baby boomers who witnessed the carnage of the tech wreck have now had to watch house prices nationwide slide 20% on average. If that weren't bad enough, Americans have lost about $8 trillion since the stock market began plunging at the start of this year. Investors who held either an index fund linked to the S&P500 stock index, or a broad basket of representative stocks over the last ten years would have seen losses in their portfolios. With the average American losing money in real estate, bonds and stocks, it seems highly unlikely they will continue to flock to the mall in droves.

Figure 1: The S&P 500 Stock Index has Returned Nothing in 10 Years

Source: Bloomherg

With the stock market down and volatility way up on the stock exchange, retail investors have been yanking their money out of mutual funds at an unbelievable pace. This has further put downside pressure on the stock market, as mutual funds and hedge funds raise cash to meet redemptions as everyone tries to de-lever as quickly as possible. But for most Americans, the process of de-levering and reducing their addiction to debt, will take some time, suggesting that the road to recovery will be a long and slow road.

But, the de-levering of America while bad, is also being mirrored around the rest of the Western world, where it seemed like everyone was leveraging up for their slice of the good life. The struggles in America , while severe, pale in comparison to tiny Iceland which is imploding after an orgy of debt. In Western Europe, the situation is dire with speculation rampant that Italy may not be able meet its debts. All around the world, cheap money fueled a massive consumption binge that saw consumers, businesses and governments borrowing like mad. All this borrowed money, or leverage, helped fuel a global boom in commodities, stocks, real estate and bonds which will take years to work out of now that the bubble has burst.

According to the International Monetary Fund (“IMF”), the developed world is expected to grow at a pace of just 1 percent in 2009. Exports, one of the few bright spots for the U.S. economy, should start to slow in response to weaker global demand, further extending the slowdown in the U.S.

Figure 2: Everyone Was Loading Up on Debt

Banks, the ones that survive the credit crunch, won't be lending any time soon. Most of them will be reducing lines of credit to shore up their capital positions as a result of subprime losses. The next wave of problems to hit the banking sector will be an uptick in commercial loans loss that should accelerate for the next few quarters.

While it will be a few months yet before investors can start to wade back into the stock markets and do some bargain hunting, that time is drawing nearer. Equity valuations on the S&P500 haven't looked this good in decades and investors are scared — two pretty good pre-requisites for getting enthusiastic about stocks again. Real Estate will likely be a sucker's bet for at least another year, as most experts are warning that anywhere between 10 and 20% downside could still be left in most housing markets.

When stocks start to bottom, the two areas that hold the most promise are in the over-sold banking stocks which will play an integral role in funding whatever growth we will have in a developed world. The other area where savvy investors should look is in the commodity stocks which are levered to the developing economies that desperately need copper, aluminum and oil to industrialize. While times are tough, smart investors will recognize it for what it really is — an unbelievable buying opportunity.

StephensonFiles is a division of Stephenson & Company Inc. an investment research and asset management firm which publishes research reports and commentary from time to time on securities and trends in the marketplace. The opinions and information contained herein are based upon sources which we believe to be reliable, but Stephenson & Company makes no representation as to their timeliness, accuracy or completeness. Mr. Stephenson writes a regular commentary on the markets and individual securities and the opinions expressed in this commentary are his own. This report is not an offer to sell or a solicitation of an offer to buy any security. Nothing in this article constitutes individual investment, legal or tax advice. Investments involve risk and an investor may incur profits and losses. We, our affiliates, and any officer, director or stockholder or any member of their families may have a position in and may from time to time purchase or sell any securities discussed in our articles. At the time of writing this article, Mr. Stephenson may or may not have had an investment position in the securities mentioned in this article
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