Everest Trends: Part 1: Economic Outlook

Welcome to the first part of my 2009 investment outlook (3-parts). I use this as a basic road map for implementing my investment strategy and have found that allocating funds is much more effective after having outlined a general outlook for the economy. Having just watched Man vs. Wild, I relate this to Bear's attempt to reach an elevated location (often a tree top or mountain peak) in order to become better acquainted with his surroundings. It often helps to remove yourself from the everyday "noise" (CNBC, etc.) and look at the big picture. With that said, my mantra for my 2009 investment outlook is "nobody knows". I have no idea what the next few days will bring let alone the next few years, but in order to allocate my funds efficiently I must form an educated hypothesis. Each month I reevaluate my current strategy and make any necessary adjustments. I apologize ahead of time for the lengthy posts...take your time and enjoy!

I will begin the outlook with a list of economic indicators that I keep an eye on. These following factors provide me with an "EKG-like" reading for the health of the U.S. economy.

Unemployment Rate/Jobless Claims
Savings Rate
Household Borrowing Rates (Mortgage, credit card, auto loan)
Corporate Borrowing Rates (Credit spreads, commercial paper issuance)
Equity Market Indicators (VIX, earnings)
Housing (Home sales, housing starts, building permits)
Retail Sales
Consumer Confidence
Futures (Copper, oil, etc.)
Baltic Dry Index (Global economy)

The Quick and Dirty:
As you can imagine, most of these indicators are pointing towards a tough road ahead. Unemployment is on the rise, the savings rate is increasing after having touched negative territory (more on that to come) and household borrowing rates are still elevated (especially credit card rates). Corporate borrowing rates have declined since November, but have recently started to climb again on the back of renewed financial worries. Equity volatility has come down since hitting record highs this past fall, but earnings have proven horrendous (see chart below). However, there are some bright spots in certain sectors that need to be monitored. The housing picture is still deteriorating due to a glut of supply and lack of buyers. There aren't too many individuals who are willing to purchase a house without a secure job and there aren't a whole lot of banks willing to lend to a jobless individual either. Retail sales made a small rebound in January, likely due to massive discounts/sales. With the average American taking a 20% haircut on their new worth, consumer confidence is hitting all-time lows. Fortunately, commodities have stabilized and the Baltic Dry Index (which tracks the price of shipping raw materials by sea) has skyrocketed since the beginning of the year. With hopes that the Chinese stimulus is beginning to work, shipping costs have increased considerably (usually a positive sign for the global economy). Having (very briefly) summarized the current state of the U.S. economy, I'll now begin looking forward.

Source: Bespoke Investment Group

Looking Forward:

Deleveraging will likely be the theme for the next few years with growth slowing considerably as consumers and companies repair their balance sheets. The U.S. consumer has accumulated a massive amount of debt over the past 18 years with household debt now representing over 130% of disposable income, up from 100% in 2000 and 80-90% in the early 90's. Unfortunately, households didn't take the hint from the last shallow recession of 2001. As you can see from the debt servicing chart below, households continued to borrow right through the last recession (mainly due to a quick recovery in home prices), ignoring the normal recessionary deleveraging process. Having not had a good bout of deleveraging since the early 90's, we will now be forced pay a steep price. As you can see from the Debt/GDP comparison below, the spread between debt and GDP will likely revert back to its normal differentiation. If this was just another shallow recession I wouldn't be nearly as worried, but since the centerpiece of this recession is credit, I'm extremely apprehensive. During previous deep recessions, individual net worth's dropped by about 5%; We are now looking at a 20% decline. Household debt has averaged about 30% of total household assets for the past five years (mind you that this was already an extremely indebted state). With total asset values having fallen by 20% and current debt loads that have actually increased, we will need to write-down approximately $3 trillion just to get back to our five-year average of 30%. With consumer credit tighter than ever and half of the 55% of U.S. homeowners with a mortgage having no equity or negative equity in their homes, the American consumer will be forced to deleverage. With consumption making up approximately two-thirds of GDP, this will likely stall economic growth for the foreseeable future. Just remember, the consumer, unlike the government, cannot run the printing presses. The savings rate has already started to increase and will likely reach double-digits before leveling off around the post-war average of 8%. Fortunately, this is a completely natural process and will result in a healthier, more sustainable economy in the long run. Just cross your fingers and pray that the government doesn't get in the way. Thanks for reading the first installment of my 2009 investment outlook and don't forget that these are all just educated conjectures on my part, so any comments/critiques are welcome.