Prediction for the Financial Markets in 2009

If you look at a few financial websites, you'll read that the stock market will dip at the beginning of this year, and then recover, ending the year above its current levels. Or you'll learn that the markets can be expected to rally at first, only to drop off sharply in the second half of the year. Or you'll be told that the markets will rise, drop and then rise again. Or that they will drop, drop some more and then drop even some more.

We would predict that almost all the predictions will be wrong. Of this we are certain. And here's why.

Governmental and political action will have greater impact on the financial markets than anything else in 2009. Consumer demand will stagnate. Business investment will be muted. Bank lending, these days, is almost an oxymoron. The only show in town is the government--or more precisely, the governments of all the world's economic players. And almost nothing is as unpredictable as government action or inaction, and their consequences.

We can expect some sort of big stimulus package from the Obama administration. But will it work? Comparable measures in Japan in the 1990s were ineffective; and there are many similarities between the U.S. today and the Japan of 12-15 years ago. Massive losses were sustained in the real estate and stock markets. The government avoided making the financial sector face up to and write off all its losses. Consequently investors felt constrained not to invest in banks whose balance sheets were opaque (on the accurate assumption that the banks were actually insolvent). Unemployment was rising rapidly even while the social safety net was increasingly strained. Consumers avoided unnecessary spending, and saving became the order of the day. Japan also had a strong export sector. Consumers in other nations, especially America, did much to prevent a collapse of the Japanese economy. The U.S. does not have as strong an export sector today, and the continuing volatility of the dollar and disappearance of trade financing threaten to cripple America's export industries.

The Obama stimulus package should focus on assisting and strengthening the real economy. Between TARP and the Federal Reserve's money printing presses, the financial sector has soaked up enough trillions of taxpayer dollars. The money flooding into the financial sector isn't finding its way into the hands of consumers and businesses. It's time to disintermediate the financial intermediaries and put money directly into the real economy. A large degree of stimulus by the U.S. government shortly after the 9/11 bombings in 2001 did prevent the U.S. economy from nosediving into a major recession, although the Federal Reserve made the horrendous mistake of not withdrawing the extra liquidity it provided quickly enough, producing the real estate and credit bubbles that have now devastated the U.S. financial sector. It's just possible that the Federal Reserve's measures, plus TARP and the Obama stimulus package, might revive the U.S. economy. But we'd predict that the Fed won't have the guts to withdraw the extraordinary levels of liquidity it's now providing, because no one likes to take away the punch bowl just as the party really warms up, even though astronomical hangovers will be the alternative.

Even the best efforts of the U.S. government, though, can be confounded by international developments. Other nations are throwing up trade barriers, by trying to weaken their currencies, raise tariffs, subsidize their industries and slow the movement of imports off their docks. In a time of recession, national protectionism is a game of musical chairs. When the music stops, there won't be enough chairs for everyone. Indeed, in the worst case scenarios, there may not be chairs for anyone. But political pressures within each nation force its government to protect its own citizens, even if the overall worldwide effect is to worsen the recession. Thus, the best efforts of the Obama administration may be undermined by other nations. In the mosh pit that will be the world's economy in 2009, there's no way to predict how things will go for anyone.

So what does an investor do? Stay diversified. Okay, diversification didn't work in 2008, when virtually all asset classes fell in value. But any investment strategy will sometimes fail. Unless you believe in Bernie Madoff, you won't find an investment strategy that doesn't involve losses sometimes. Diversification is like capitalism--it's imperfect, but better than the alternatives. Today, you should think about being more conservative, keeping some dry ammo in the form of extra cash. Use this cash opportunistically when good potential investments pop up. Meanwhile, concentrate on that New Year's resolution to lose the love handles, and you'll have a way to get something positive from 2009.