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In these
turbulent times, it’s hard to grasp how serious our current
economic situation truly is. The news media, desperate for a
story that will capture an audience, are claiming that we are on
the verge of financial Armageddon. On the other hand, you can
find financial pundits who claim that we are merely experiencing
a “hiccup” and that the economy will recover rather quickly. So
who should you believe?
I was
fortunate enough this week to have the opportunity to hear one
of Wall Street’s leading economist’s speak very candidly about
the current state of the economy. Leading economists have a
reputation of rarely go out on a limb, but simply presenting the
facts as they see them. That made this economist’s comments even
more sobering as he very bluntly stated that we are facing the
“greatest crisis since the Great Depression”.
Consumers Face Perfect Storm
American
consumers have spent freely over the past few years, completely
unconcerned that their expenses exceeded their incomes. This
seemed irrelevant for many, as their escalating home values and
readily-available credit lines provided additional sources of
cash. Now we are slowing facing the ugly reality of our
shameless living.
Home
values are now falling at the same time that oil prices and
basic commodity prices are rising. Unemployment, which has not
been a concern for many years, is expected to spike in coming
months. Consumers are going to be forced to cut back their
spending to realign with their income levels. Over the next
decade, economic growth could be hampered by reduced consumer
spending.
It’s been
surprising to some that the American economy has remained so
resilient in the face of disaster. However, that is expected to
change very soon, as the one component of GDP that has kept us
from a recession – exports, is falling fast. The recession is
spreading to Western Europe which will lessen their demand for
American goods. Even in China, where government subsidies have
insulated their booming economy from the effects of rising oil
prices, are suddenly finding those subsidies reduced.
Most
Serious Crisis Since Depression
Back in
August - September 2007, there was concern that we could
potentially be facing the “most serious crisis since the
Depression”. By March of this year, many leading economists are
very confident that this is the case.
Just like
with the Great Depression, this recovery will need to be
calibrated not in months, but in years. It could take another
decade for the markets to fully readjust. At the very least, we
are looking at 2-3 years of dislocation in the markets.
Investors
should not be looking for a recovery in the housing market in
the near term either. We are only in the third year of a housing
downturn, following an unprecedented run of 14 consecutive years
of price appreciation. Housing cycles are notoriously lengthy –
lasting an average of eight years. Playing the law of averages,
we should not expect a housing recovery until 2013.
Oil Price
To Continue
Rising
One bright
spot for investors (although not for consumers) is that ovver
the long-term, oil prices are going to continue to rise. The
world is heavily dependent upon oil and there is only a limited
supply. In the next 12 months, oil prices will probably trade in
the $80-150 range.
Of course
these escalating oil prices are leading to another phenomenon –
the transfer of wealth. America, along with much of the
developed world, is transferring its wealth to the Middle East
in exchange for black gold. Individuals and entire nations are
becoming tremendously wealthy due to the rising oil prices. Even
Russia has emerged once again as a super-power due almost
entirely to the fact that oil now trades above $100 a barrel.
Proceed
With Caution
For the
individual investor, caution remains the watchword. It’s not out
of the realm of possibility for US equities to post negative
returns over the next ten years. This trend will only be
accentuated by the withdrawal of baby boomer wealth from the
financial markets.
At the time this article was
published, the author did not have a financial position in any
of the stocks mentioned in this article.
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