And the annus horribilis comes to an end on an upnote. The Dow rose 108 points today while the S&P 500 rose 12. A nice day, but for the year the Dow lost 33.8% before dividends and the S&P fell 38.5%. It was the worst year for stock prices since Herbert Hoover was president, when the Dow Jones Industrial Average dropped an all-time record 52.7% in 1931. This was the third worst year in the 112-year history of the Dow, with 1907′s 37.7% loss in the #2 position. For the S&P 500, it was the worst year ever since that index was created in 1957. Annus horribilis maximus, I’d say.
The conventional forecast is for a bad first quarter in the economy, a weak first half, and an improving second half. Therefore, the conventional wisdom is looking for a bad first half for stocks, and a better second half. I don’t know why people keep thinking that the stock market is a coincident indicator that moves up and down with the economy. It’s not. It is a leading indicator — actually, the best leading indicator of all — and moves up and down well in advance of the economic news. By the time the surveys, polls, CEOs and talking heads are giving the all-clear signal, the stock market will have moved up 20% to 30% and be well into new bull market territory. Happens every time.
The problem this time is that I think the consensus outlook is wrong. I agree that the first half will be weak, but I think the weakness in real terms will continue through 2009 and well into 2010. I underlined “in real terms” because at some point monetary inflation is going to overwhelm the three major deflationary forces, the dollar will collapse, and in nominal terms the stock market will go up even as the economy flounders. It’s very hard to predict when that point will come, but my best guess is that it won’t come before the middle of 2010. However, I could be wrong…maybe the Chinese or the Japanese will realize they are about to be taken for a ride, and start dumping their dollar reserves sooner. I watch for this every day, and I’ll let you know the moment I see it start happening.
Why should you care? Because if we were headed for deflation/depression, as so many think, you would want to own safe bonds and cash. You would want to be out of debt, real estate, stocks, commodities, precious metals — anything that has a price, because prices will be heading down.
But if we are headed for sky-high inflation, as I believe, the last things you want to own are bonds and cash. They lose real value minute by minute in a hyperinflation environment. You want to be in debt if it is fixed-rate debt that you can repay with cheap dollars in the future. Real estate, stocks, commodities and precious metals all soar in price as inflation heats up. I understand why so many believe a big deflation is coming. The three major deflationary forces are:
- Demographics — the aging of the baby boomers
- The Credit Collapse — not just the current pain, but the permanent change in consumers’ attitudes going forward
- Technology — the whole world is now riding Moore’s Law of ever-falling real prices
The first baby boomer hits 65 in April 2009, and if the past is any guide, retiring boomers will be spending much less than they have been. Less spending in retirement is not the problem, it is the sheer number of boomers that is the problem. From birth to now, every stage of the boomers’ lives has had an outsized impact on society and the economy. The massive economic growth they powered in their 30s, 40s and 50s is about to turn into a massive economic drag. That’s deflationary.
The credit collapse is obvious to all. Even though Hank Paulson seems to think the cure is the “hair of the dog,” it looks like his prescription for easier credit and more consumption is falling on deaf ears of both sellers and buyers. Banks are making it tough to get a loan at any price, and consumers seem more interested in paying down credit cards and building a little rainy day fund than taking on more debilitation debt. The debit card is the new credit card. That’s deflationary, too.
The Revenge of the New Economy
After the collapse of the dot.com stocks, the fuddy-duddies and Establishment power brokers who never understood technology took great delight in skewering anyone who had ever believed in the New Economy. They confused the financial games in the stock market with the worldwide revolution in the economy, business, the way people worked, lived and entertained themselves. One famous commentator specifically named George Gilder and yours truly as wrong-wrong-wrong. Then he sent his daily newsletter to his 300,000 subscribers. Did he print 300,000 copies every day? Put postage on 300,000 envelopes and mail them out? And do it all for free? No, no and yes. Of course, he just pushed a button and sent an email to 300,000 people every day for virtually no charge, saying he sure didn’t see any so-called New Economy, harrumph, harrumph.
Well, maybe now he sees it. We are living in the New Economy, and learning that it can be rough. Companies use the Internet to manage the design and production process worldwide, outsourcing every step to the least expensive provider that hits the quality standards. Then they use the Internet again to build demand worldwide, provide shipment tracking, customer service, technical support, customer newsletters, follow-on marketing — you name it. The good result: Lower prices (deflation), faster change, improving living standards in the less developed countries and a higher quality customer experience. The bad result: Hollowing out of U.S. manufacturing, failures of U.S. retailers and mall operators, bankruptcies of companies that can’t keep up.
New Economy that, unbelievers!
The three deflationary forces I spoke about are ripping through the U.S. economy, with varying degrees of fallout on the UK, Europe, the CRIB countries (China, Russia, India, Brazil) and the rest of the world. Left to themselves, they would force a quick, brutal deflationary adjustment to the New Economy realities. But they won’t be left to themselves, because standing in their way is the arch-enemy of deflation and the Great Depression, Fed Chairman Ben Bernanke. To be fair, the rest of the Fed has swallowed the same anti-deflation line. As Bernanke famously said to Milton Friedman about the Great Depression: “You were right. We did it. But we won’t do it again.”
Nope, he won’t. He’ll do something much worse. He’ll try to stop deflation by printing money, and the resulting hyperinflation will be very painful for any debt holder, anyone on a fixed income, and any country holding a lot of U.S. dollars. Then it will end in the Greatest Depression, anyway, much worse than the 1929-1932 experience.
All this is the topic of a book I am finishing now. The takeaway is that there should be a very strong stock market rally dead ahead, which probably already started, as the market discounts the consensus view for a recovery in the second half of 2009, fed by enthusiasm over the Obama administration’s new spending programs. We’ll know the rally is real when the S&P 500 breaks out of the 850 to 910 range we’ve been consolidating in for three months since the initial bottom on October 6, and today’s action sure looked like the beginning of that breakout. Investors have built up an $8.85 trillion cash hoard, equal to about 75% of the market value of all U.S. public companies. That’s the highest ratio since 1990, and from the eight previous peaks in the cash/market value ratio, the S&P 500 averaged a 24% gain over the next six months. So I think there is still enough time and sideline cash to get the S&P up into the 1250 to 1550 range in the first half of 2009. After that, though, I expect the next and largest leg down of the bear market, until finally Bernanke prints enough money to unbottle the inflation genie and nominal stock prices take off in a frantic hyperinflation.
The good news for us is that we can and will profit from all three deflationary forces. Retiring baby boomers means a dramatic increase in health care spending, which is terrific news for the biotech and medical device companies in our portfolio. With roughly 25% of the health care dollar wasted on pushing paper around or failed drug trials, there are many other opportunities for new companies to create a big, fast-growing business even in a bear market.
The credit collapse means people will be spending less, staying home, and finding their entertainment in new ways. Consumer electronics prices fall every year thanks to Moore’s Law, and engineers know how to keep that downward-sloping curve going until at least 2020. Again, opportunities abound for companies that develop products to meet these new customer needs.
The New Economy, driven by technology, will continue to change all the rules about manufacturing, selling and supporting products. We own stocks of companies that will take advantage of the new opportunities to produce real growth while the rest of the world is shrinking. Remember, tech company managements are used to seeing prices fall 25% a year. They’ve been growing companies in a deflationary pricing environment for 50 years! Deflation may be a harsh wake-up call for GM and Ford, but it’s business as usual for Hewlett-Packard and Intel.
We’ll also profit from the hyperinflation to follow, but that’s the topic of another Radar Report and a follow-on book. For now, I would say don’t be an optimist or a pessimist — BE A REALIST! That plus a good dose of common sense is what will get you through the next several dangerous years. There is not another baby boomer demographic coming, and there won’t be another credit expansion to drive up GDP for quite some time. We can’t correct 16 years of excesses in a normal, 16-month bear market. Without more appropriate Fed and fiscal policy, the U.S. may permanently lose its world leadership status to China, just as the Great Depression marked the end of British domination as the torch passed to the U.S. Unless the Obama administration does a 180o, the monetary and fiscal policy of “no Great Depression at any cost” will lead directly to hyperinflation, a dollar collapse, and the Greatest Depression any of us will ever see.
Yet we will come out of even that worst case invested in strong companies generating real profits. England didn’t cease to exist as a second-class power after WWII, it was just that their new winners were entirely different from the old blue chips. The U.S. has an entrepreneurial spirit, great universities, excellent scientists (although not enough of them), a strong venture capital tradition and experienced technology managers. We will survive as a country, and prevail as technology investors — and more.
Could You Make Money If You Knew Where The Next Bubble Will Be?
There was a bumper sticker around Silicon Valley in 2003/2004 that said: “Lord, Just One More Bubble.” Well, they got it. Trouble was, those who benefited from the dot.com bubble and then went down the tubes mostly missed the real estate bubble. Those who played the flipping game in real estate mostly didn’t get out in time. Instead, the dot.com bubble ruined the career and retirement plans of one group of folks, while the next bubble in real estate took out an entirely different group when it popped. Then we had the oil price bubble, complete with obviously manipulated prices on the New York Mercantile Exchange. It popped and oil fell 75%, but the damage seemed to be limited to the big dogs like Boone Pickens and those who bought Canadian energy royalty trusts for the yield.
So what if I could tell you what the next bubble is? Would you use that information to make a fortune? Would you get out in time, or even short the bubble as it popped?
Good, because believe it or not, the next bubble is already here, right now. It is caused by — who else but the masters of bubblemania?–the Fed. And it is about to pop. Will you profit? I am going to expand the coverage of New World Investor somewhat to include a few non-tech investments that will be huge winners in the new financial and economic world we have entered. That’s what I meant by “prevail as technology investors — and more.” This is a “get ready” introduction to making money as the next Fed-caused bubble pops, ruining many more companies, hedge funds and investors.
If I didn’t label the chart below, would you guess it is Amazon.com from the 1999 Internet bubble, or an exchange-traded fund invested in Treasury bonds?

Source: StockCharts.com
Yes, it is Federal government debt where the next Fed-caused disaster lies. As you know, bond prices move in the opposite direction from bond yields. With the Fed cutting short-term rates essentially to 0%, and the inflationary impact of their out-of-control printing presses still in the future, the entire yield curve has shifted much, much lower. Bonds have soared, as Treasurys of all maturities returned 14.9% this year, the most since 1995 and the first double-digit year since 2002. But what’s next?
The Fed has embarked on a new, dangerous strategy: “Quantitative easing.” That means printing lots and lots of money, counting on the money supply rather than credit easing to kickstart the economy.
Panicked investors have already driven the yield on the 20 year Treasury bond down to 2.20%, and on the 30-year bond down to 2.65%, both around historic lows. Yet the Fed says they may start buying 10 year notes and 30 year bonds to continue to drive down rates. That’s why I am not pulling the trigger today on my recommendation to make a fortune when the Bond Bubble pops. The Fed is going to take that already-extended bubble chart above and blow even more air into it, making the inevitable pop even worse. Either investors are going to find alternatives to such mangy returns or the dollar is going to drop so far that imported inflation takes off. Either way, the pop is coming.
When it hits, we will buy another exchange-traded fund, the Proshares UltraShort Lehman 20+ Year Treasury (TBT), which goes up twice as fast as the TLT goes down. As you can imagine, the TBT chart is a disaster:

Source: StockCharts.com
Volume has exploded in the TBT during December because investors are trying to pick the bond market’s top. That’s another argument in favor of waiting, because any announcement that the Fed is buying long-term bonds would start a sharp sell-off in the TBT as these new speculators bail out. But when this bubble pops, it is going to make the subprime mess look like kid stuff.
2009 Forecasts
I’ve already given you my main overview of 2009, so here is a short list of a few specifics:
- Personal computer sales will fall about 7% to 10%. Laptops will be flat thanks to the new netbooks, but desktops will be very weak, even in Asia
- Cellphone sales will be flat to down about 5%, with the best results at the extremes — high-end smartphones and entry-level, cheap handsets
- Semiconductor sales will be down 5%, including DRAM down 15%
- The S&P 500 earnings will come in around $50, which already is discounted in the market. Yes, I know the analysts have only cut to $70 at this point, but no one believes them. If $50 is wrong, it will probably be too high.
- March quarter earnings will be terrible, but that is already discounted in stock prices. Unfortunately, the June quarter will be worse, and that is not discounted yet.
- There will be far more bankruptcies in 2009 than in 2008, with many household names going under. At the San Francisco Money Show I said GM would be bankrupt by the end of the year. I didn’t count on the Feds loaning them $15 billion (GM plus GMAC) when the entire market capitalization of the company is just over $2 billion. GM can now survive until the end of March, so Chrysler will go first. Chrysler will be just the first of hundreds of leveraged buyouts that will not be able to make their debt payments, and will go bust. Interestingly, those that can survive this period due to better interest rate coverage or longer debt maturity schedules will be huge winners in the coming hyperinflation.
- Commercial real estate, especially retail malls, often is financed with short debt maturities and/or adjustable rates. Either way, the whole sector is in big trouble in 2009. Is the American taxpayer willing to bail out landlords? Probably not.
- Here’s a shocker: China’s GDP will decline in the first half of 2009 and show no growth for the year as a whole. Here’s a second shocker: They will not get back to double digit growth ever. But sometime after 2011 they will recover to 5% growth for a number of years, which is a heck of a lot better than the U.S. or Europe will see. Power generation in economies where manufacturing is a high percentage of GDP correlates well with GDP growth, and China’s power generation declined more than 8% in November.
- The Alt-A mortgage resets in 2009 are about five times the size of the subprime problem, and now we are in an environment of falling house prices with 10% of all mortgages already seriously delinquent or in the foreclosure process. Another trillion dollars in losses will hit lenders in 2009.
- Even during the worst of this mess, some areas will do well. Biotech companies with enough cash or deep-pocket partners will continue to develop great new drugs, especially in personalized medicine. Companies will move to cloud computing to save money. Video chat will finally take off, first using PC and living room TVs, and then on cellphones. I’ve already mentioned netbooks picking up most of the slack as desktops and traditional laptops take a hit in 2009. WiMAX will continue to spread like crazy, especially in South America, Russia, China, India, Africa and Asia. Electric cars will finally become a reasonable prospect, thanks to the Tesla and the Chevrolet Volt. (The record-setting electric Taurus I ran at the Bonneville Salt Flats has a higher top speed higher than the Tesla, heh heh, although their 0-60 MPH time is better.)
- Blue-ray DVD player prices will fall well under $200, and become the hot holiday gift for 2009.
- Apple will have real competition for the iPhone for the first time. Steve Jobs will not be running the company by the end of 2009, but Apple will continue to do relatively well as they push sales of the iPhone around the world.
- Yahoo will be dismantled and sold in 2009.
- Outsourcing will continue to grow about 5% a year as U.S. companies look for even more ways to cut costs.
- Security software sales will increase to match the increase in crime that occurs during every recession. Microsoft will offer free consumer security software in the second half of 2009 to try to keep their user base on board for Windows 7, due to replace the troubled Vista operating system. But customers will increasingly choose Firefox over Internet Explorer for security reasons, and Open Office over Microsoft Office to cut costs.
- The first tech-savvy President in U.S. history will start the government on the path to a unified, citizen-centric database to cut costs and increase accountability.
Taking my own advice, I am not optimistic or pessimistic about 2009 — I am trying to be balanced and realistic. We are invested in many great companies doing great things, even though their stock prices are temporarily down. Those who introduce new products and show revenue and earnings growth in 2009, or position themselves to take advantage of the new Administration’s priorities, will shine brightly against a background of recession, ongoing credit problems, bankruptcies and poor earnings. When that $8.85 trillion comes off the sidelines, a disproportionate share of it will flow to the companies and industries that are doing well in a tough environment. That’s what the New World Investor portfolio is all about.
Have a happy and safe New Year’s holiday, and remember that we will not only survive but prevail together in 2009 and beyond.





