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New Year Market Conditions

January 2, 2009 – 1:42 pm

This was another holiday shortened week as the last days of 2008 wound down. Everyone is happy to see 2008 go. It was one of the worst stock market years since the Great Depression and no one anticipated the disaster in the financial industry that spread world wide. Looking back, the commodity sector rallied strongly for the first part of the year before absolutely collapsing in the second half. The rise and fall in oil and gasoline prices clearly demonstrated the horrific volatility in 2008. There was no sector in the stock market or for that matter any asset class almost anywhere in the world that rose in 2008. All fell sharply and the only safe place was cash. However, cash at this point is earning nothing as the treasury yields have fallen with the Federal Reserve lowering the Fed Funds rate to zero percent interest.

That was 2008. However, as investors we must look forward. Will 2009 repeat 2008’s performance? Most experts don’t see that and frankly it would be almost unheard of if it did. Even in the Great Depression there was a rally after the first year’s severe fall in stock prices. As stated last week, mortgage applications are spiking up, and two weeks ago I quoted Bob Brinker’s research in stock prices rising following a year when they were down 50% from a peak. Of course that does not have to happen this time but it is a compelling argument for a higher market in 2009.

For the economy, if there is going to be a recovery in the new year, it will start with housing and then get a boost by the very large infrastructure spending the Obama Presidency is preparing. The Federal Reserve will start buying troubled mortgages in January and have set up a goal of $500 billion by mid 2009. Just the announcement of this effort in December lead to a cut in mortgage rates by 1%. When they actually start buying these mortgages from banks that will set a floor in the price of these troubled assets for the banks and provide them cash. That relief may well give banks reasons to start loaning again. Banks are getting free money to lend out to the public at whatever rate they can charge. I wish I had that deal.

Fear is still high but is starting to fade. You can see it in the various interest rates banks are willing to accept and a reduction in the volatility in stocks. For homeowners there is going to be a once in a lifetime opportunity to reduce mortgage payments by refinancing, and for new buyers who can qualify for extremely low 30 year fixed mortgages. It is possible to see 4% sometime in 2009. Add that to very low home prices that will stay weak in 2009 and you have an extreme buyer’s market.

These fundamentals for our economy should result in a recovery in late 2009. The stock market historically starts to rally six months in advance of any recovery in the economy; at least it has always done so in the past. We may be seeing the first signs of that already, but it is going to be a bumpy ride.

There are dangers for 2009. The Middle East is the fist thing that comes to mind. Iran trying to obtain a nuclear bomb is destabilizing and of course that will affect oil prices. But since the world is already fearful, any conflict in that part of the world will be felt more acutely by the markets. We have seen that in the Hamas/Israeli conflict, which is fairly contained. It caused oil prices to rise a little so what would further trouble in that part of the world cause?

Of course any collapse in a large bank would cause trouble. However, I doubt any government around the world would let that happen. Unrest in emerging economies might be a problem. With world economies slowing, job creation has also slowed, and in places like China that can be a big issue resulting in citizen unrest. Then of course there is the unforeseen and unforeseeable event that could happen.

Therefore anything ‘can’ happen but rational people must look at probabilities not possibilities. What are the probable outcomes for 2009? I think it is a stronger stock market with a recovering economy late in the year. Inflation is likely to return when the economy starts to recover. These are the highly probable events. This is certain- the economy is weak and will stay that way for a while and it is going to be an eventful year.

Happy New Year. Let’s hope for a profitable one as well. Chances are good that it will be.

P.S. Attn: Bay Area Investtalk Listeners:
We’re excited to announce that we’ll be talking to you in the new year on a new radio station! Join us at AM 860, a 50,000 watt station that is heard in a much wider area of the Bay Area and beyond, including Carmel and Sacramento.

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