Shaping a Portfolio for 2010 (II)–Where We Are Now

The first step in figuring out how the economy develops from here is to try to describe the forces that are shaping it today.  I think the most significant are:

1.  For almost two years, we have been in a domestic housing slump.  This is the aftermath of a long housing boom fueled in it last days by extreme levels of speculation–by individuals buying houses they couldn’t afford (or intended to quickly sell to a “greater fool”), and by banks making mortgage loans to unqualified borrowers.  There are signs that the worst may be over for single-family homes, but not for apartments.

2.  Last year, the public, the regulators and the financial companies themselves discovered that the securities trading desks that the financials had established over the past ten years were not the immense profit centers that the company accounts had portrayed.  Instead, these trading desks had lost so much money, with top management unaware of what was going on, that they had driven their firms–big institutions like Citigroup, AIG, Lehman or Merrill Lynch–into bankruptcy in all but name.  Since many of the securities being traded were either backed by worthless mortgages (para. 1) or were IOUs from the now-defunct firms, even the “winning” side of these trades were money losers.

The realization, late last year, of the extent of the losses made financial companies effectively stop making new loans of any type, shutting off the life blood of economic growth.  This is by far the largest problem we have. Since then, governments around the world have been taking all sorts of extraordinary measures to restart the normal process of credit creation.

We’re probably well past the worst.  From a stock market perspective, several issues remain:

the credit creation process still isn’t back to anything near normal.  Lack of credit continues to send negative ripples through world economies

the north-east US, the epicenter of the problem, will likely struggle economically for a considerable time

confidence in US institutions has been damaged.  This is not only the banks.  Investors seem to regard Congress as dysfunctional and to worry that, as a result, the government will not be able to fix the banking problems.  I’ve never seen this kind of lack of confidence before, so I find the phenomenon tough to evaluate.

in the longer term, the financial losses will be underwritten by taxpayers

3.  The internet continues to do its work of creative destruction.  The economic downturn has accelerated the pace of change.  Newspapers and local TV stations are the current focus of rapid change.  Book publishing may be next.

4.  The Detroit-based “Big Three” car companies have been losing market share for thirty years.  For almost that long, they have been standard studies for MBAs on how not to run a business.  Ford appears to finally begun restructuring a few years ago.  It appears restructuring will be forced on GM and Chrysler.  I don;t think this is the significant stock market issue it might have been four or five months ago.  But Michigan will likely find the economic going hard over the next few years.

To summarize:

Bad News:       credit crunch

housing slump

decline of paper-based communication

problems will take some time to fix

Good News:      the problems are out on the table,

their rough size is understood, and

the government is working to fix them

stocks are cheap

we can guess economic growth will resume in late 2009

the economy in the US isn’t doing as badly as feared

a perverse plus:  anger at bank bailouts = less political

pressure for a potentially disastrous bailout of


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