Outlook for 2008

It's been a while since the last post as I got caught up in holiday activities. I was also waiting for some more clarity on the economic front, which was provided this week. A US recession has probably not yet started, but the economy appears to be on the edge, and the trend is not good. Manufacturing PMI was below 50 this week and December employment numbers were weak. Holiday sales were also pretty weak. Consumers have not yet rolled over but they seem to be worried. No wonder -- with house prices falling, foreclosures rising, and companies starting to announce mass layoffs -- it is only logical. FOMC minutes showed that the Fed is much more worried about the weak economy than inflation.

Equity markets were weak in the Christmas-New Year's period and this is ominous. Typically the market rallies pretty hard around this time of year, and for it not to happen means that the market is weak. The large decline in the Nikkei yesterday was also a warning. I am not yet ready to declare a bear market (I will wait until SPX decisively breaks through the August/November lows), but it sure feels like a bear market. Rallies are not sustained; if the market opens higher, it falls towards the end of the day. And there are few people talking about the fact that the market is well off its highs. The bond market has rallied smartly over the past week and yields are now back where they were several weeks ago. Ditto with currencies.

Gold has also jumped back up and is now above its all-time high. Part of me wants to take this a buy signal and increase my position, but I think that the current gold rally is premature. People have decided that they do not want to increase their equity position so they are casting around for alternatives and they choose gold. But gold will probably get hit in the impending equity meltdown, even if it is one of the last to fall. That will be the time to increase gold, along with oils and agriculture.

Although I generally dislike it when seers write their predictions for the upcoming year (as they are usually wrong), in my case it is a good idea, as it forces me to order my thoughts and justify my positions. Most importantly, it provides a record of my thoughts at this point in time, which is one of the major reasons for this journal.

My long-term outlook for monetary policy is based on the fact that consumers (and some corporates) have undertaken a massive increase in debt over the past 7 years. The Fed knows that a debt-deflation spiral is real possibility so they will do all they can to prevent it. The only way out is through easy monetary policy and higher inflation -- essentially inflating some of the debt away and allowing households to gradually repair their balance sheets. That will probably take several years. Once that is more or less complete, and inflation expectations start to really get out of control, the fed will be forced to jack up interest rates, causing another recession.

So I continue to expect a major decline in equities globally as the economic reality sets in. This could be imminent (SPX is down over 2% as I write this), or it could be next month or in March. But it is probably sooner rather than later. Bonds will do well but commodities (including gold and oil) will probably get hit, though they may fall slightly later. Once that happens, it will probably a good idea to exit long bond positions and increase exposure to gold, agriculture and oils. Probably emerging markets as well. I expect these to be the major growth areas over the next few years. But I will probably stay short of the major indices for a while longer. The upcoming recession could be severe, and equities probably have far to fall.

MARKET POSITION: EQUITIES - SHORT (9 units); GOLD - LONG (1 unit)