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The US Economy The American consumer has proven to be very resilient over the years. Rumors of their impending demise have been foretold since the beginning of the decade and here we stand at another crossroads. Consumer spending accounts for more than 70% of GDP so while everyone focuses on manufacturing, production, and service figures they overlook the one figure that matters most, retail sales. America’s largest retailers came in with retail sales growth over 8% in the days following Thanksgiving showing that the expected slowdown is not occurring as expected. Weak December sales numbers are proving to be a counter to the strong November sales. The 3rd quarter GDP numbers for 2007 were skewed by higher inventory buildup ahead of the Christmas holiday. Since 70% of GDP is due to the US consumer I expect a 4th quarter GDP number in the 2-2.5% range. Looking forward, I do not expect a recession in the traditional sense, which is defined as 2 consecutive quarters of negative GDP growth. We will see a very low number in the second quarter of 2008, but depending on inventory levels, we may see a bump up during the 1st quarter. The 3rd and 4th quarter numbers are up in the air and depend on many factors. Because of the continued effects from the housing market we may see a recession backdated into 2007 but this is not a recession in the traditional sense. Businesses will cut back their 2008 budgets due to economic and political uncertainty. I expect layoffs to increase. Business spending will not begin to pick up until 2009 and the political waters clear. Inflation will come down slightly from the high levels we are at now but do not expect a return to the 2-3% level. CPI and PPI inflation will remain in the 5% area. The best description for the US Economy in 2008 can be deemed stagflation. Slow economic growth combined with higher than normal inflation. The 2008 Elections The election is too early to call but based on the tea leaves I am reading I believe that Hillary Clinton will win the Democratic nomination and Presidency in 2008. The Republicans appear to be disorganized and fundraising dollars are filling the Democratic Party’s coffers. During the campaign, the Republicans will attempt to paint the economy as strong while the Democrats portray a recession on the horizon. In Congress, it would not surprise me to see the Democrats pick up at least 5 seats in the House and 3-5 in the Senate. For the record, I am a registered as an Independent. The Banking System and Federal Reserve The Fed will cut the Discount Rate and Fed Funds rate at least 2 more times in 2008 with the likely scenario being 3 cuts at the first 3 meetings. A cut over the summer is possible but the Fed has a habit of holding off on moves around Federal Elections. This time will be no different. The effects of tighter lending standards will become more apparent as the credit which never should have been extended into the system is fully removed. The tighter lending standards will offset the rate cuts by the Fed and additional liquidity injections causing more problems. Housing prices will continue to decline. There needs to be a point of balance where housing prices equal the point where the buyer can purchase a 30 year fixed rate mortgage with 20% downpayment. This may occur in 2008 but bottoms will occur at different times for different areas of the country based on each areas balance point. The US banking system should see substantial charge-offs. There will be more to come as the system balances between writing off bad assets and rebuilding capital. Dividends will be affected next year. By the end of 2008 the banking system should be back on firm footing. Money supply growth will continue to charge ahead. The only thing stopping additional liquidity growth is a printing press breaking down. Global Stock Markets Looking back to the 1800’s, years ending with 5 were the best years for stock market returns. The next best year? Years ending in 8 and since 1891 only 2 years were negative, 1948 and 1978. The fourth year of any presidential cycle is bullish for the markets as Congress primes the pumps and spends money like it grows on trees in an effort to get reelected. Expect the pattern to continue. The Dow and S&P will see lower prices in the first and second quarter before the pre-election rally kicks in. Expect a selloff after the election until the cabinet is announced. Everyone will be waiting to see who is selected for Treasury, State, and Defense positions. But by the end of the year we will see a decent return. Nothing more than 15% though. Technology will top out on increased economic concerns. The pool of winners will get progressively smaller as the year goes on. The ideal place to be is in markets decorrelated to the US economic slump. Dividends provide a buffer against capital losses. The lower the Fed Funds rate goes the higher gold will run. Next year people may be predicting great things for gold but a 15-20% move up will be satisfactory to me. Silver may outperform gold in the year to come but will be up as well. Oil will have another good year but nothing like this year. Again, a 15-20% gain will be satisfactory to me. Outside the US, European markets will begin to feel the full effects of the dollars collapse. I do not feel good about European markets next year. Selected Asian markets will do well. The lesser markets will outperform the larger, more developed markets. Depending on Thaskin’s lust for power, Thailand may see continued political turmoil. But the business community will continue to see the benefits of the trade agreement with Japan. Japan will continue to trend lower until there is either a commitment to reform or an election. Expect no rate increase by the BOJ. Taiwan will begin to move closer to China. South America is my only unknown. Brazil will continue to grow closer economically with the Middle East and their independence from foreign oil will benefit the economy in the long run. My favorite sectors for 2008 are gold, sugar, silver, and cotton.
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