Vad's Best Ideas

"In nature, there are neither rewards nor punishments; there are consequences"

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You know this SLO experience has in many ways been a great training ground for me. It has helped me to for the first time organize my thoughts in somewhat clearer manner and forced me to put them in writing. I have posted here at SLO in a relatively consistent manner, and have been successful at using it to increase the portfolio value of my "virtual investors". I have also been fortunate to have a group of people who actually seem to read and enjoy my posts. Now I am going to go out on the limb and will put my take on what I think might happen on the economic front in 2008. Take it for what it is - an opinion only.

The key fundamental principle behind my projections is my core belief in cause and effect relationship of every economic transaction. However, it is also clear to me that because the real world is actually driven by "human" emotions, rather than logic, not all of my logical relationships will come to fruition. At least not in 2008...

US Economy and Inflation
My opinion on this subject is the same it was 5 months ago- economy is going to end up recession sooner rather than later. More rate cuts will merely delay the inevitable and exacerbate the damage. Inflation threat is not only real but also, as the fact that the PPI jump on Friday was highest in many years, suggests that it could be on the verge of spinning out of control. It is certainly true that with a prolonged economic slowdown prices could and should decline. My fear here is simply that consumer inflation expectations appear to have been significantly altered by continued rise in food, healthcare and energy prices and the lag between expected declines in commodities will take a long time to feed back into the lower wage expectations.

I now think that when if and when Fed comes to their senses and stops or at least slows down the rate cutting frenzy for at least one or two meetings, equities around the world might enter a period of another significant downturn. 2008 earnings expectations for most companies still look absurdly high with most analysts predicting another hockey stick sometime during the third quarter. We've seen all that before... Let's not forget that the real damage to most financial companies' earnings who still account for a large share of earnings did not occur until the second part of the year, so growing over the terrific results of the first part of the year will still be a tough cookie to crumble.

Do you actually think that Goldman could earn as much money in 2008 as it did in 2007? Private equity boom of first part of the year that drove the lending frenzy is over now and it won't come back for while (at least not in 2008). My best guess would be that housing prices have not yet bottomed simply because of the supply demand imbalance- inventories are at all time highs, builders are still finishing off a lot of new projects and labor market is not that healthy. All-in-all I think that we still have a lot more dilution to come in the Financial services sector. Thus I believe the current rebound is temporary and that we might see new lows here. Consumer discretionary sector and anything else that is cyclical (except US based manufacturing) to me still has downside potential. Healthcare has not performed as well as it should, triggered by weakness in Big Pharma. I think that sector rotation could come in play here with healthcare outperforming in 2008. I also like consumer staples, large-mid cap IT, utilities and industrials that have solid manufacturing base in US. I also think that Large-Mid caps will still hold solid advantage over Small caps in 2008.

To be continued in Part 2