Another look at my 2008 predictions

By Edward Harrison On Oct 8, 2008

In July, I made my ten predictions for the markets and global economy for the rest of the year. Some of my predictions were pretty pedestrians, and some were fairly bold. Let’s take a look and see how I’m doing.

Here’s what I originally said:

Oil prices will dip below $100 before year-end. Let’s face it $130-$140 oil is a real deterrent to energy consumption. After weeks of demand destruction, the price of oil is finally reflecting this fact. Moreover, with the global economy headed for recession, expect oil prices to fall sharply. This will be a great relief for consumers and a net help to GDP.

Inflation will fall globally. With oil prices coming down sharply, inflation will recede too. Therefore, I expect to see headline inflation in the US, the UK and the Eurozone in particular head down into the sub-4% area by year’s end, another happy turn for the economy.

The Fed will lower rates. With oil prices down, the Fed can give up its talk about being hawkish on inflation. We didn’t believe them anyway! When push came to shove the ECB acted and the Fed did not. With inflation sinking, the Fed can focus its policy response on the turmoil in the financial services sector.

A major financial institution will fail. The happy talk about the credit crisis being over is rubbish. It is now plainly obvious that writedowns have just begun in earnest. With a global recession looming, weaker financial institutions will go to the wall. A major bank will fail. My money is on a super-regional in the United States.

2nd quarter GDP in the U.S. will come in above 1%. A pall of gloom has spread over North America, Europe, Japan, and ANZ. People are predicting the worst of all possible worlds for the US. However, this is not to be. The U.S. may be in serious trouble but it won’t be reflected in the Q2 GDP number to be released this week. Why? First, the GDP deflator will understate inflation. Real GDP may come in at 4-5%, suggesting a negative real number given the CPI is at 5.0%. But, the GDP deflator has not been keeping pace with the CPI. Moreover, the stimulus package has had its wanted effect in stimulating some consumer demand.

America will need another stimulus package. By September, it will become apparent that the U.S. economy is headed for recession. Politicians being politicians will need to forestall this with the election coming up in November. Therefore, they will vote to pass a second stimulus package. The great thing about the second package is that the year’ Federal deficit associated with it won’t be apparent until one year later.

The Eurozone will fall into recession. Europe looks weak. It seems ironic that a downturn that started in America will first be confirmed as recession in Europe, but the numbers point in that direction. Spain, Ireland, Germany, Denmark and Italy are all looking particularly weak. Denmark is already in recession. Ireland and Spain probably are. The whole Eurozone average will follow soon.

Britain will enter recession. The UK is looking as weak as Europe. And with a property bubble and high debt burdens, British shoppers are in no mood to keep on spending. The result will be recession the UK.

A major home builder will bust. The latest threat to house builders in the UK, Spain, the U.S. and Ireland is land prices. As a property bubble takes hold, home sales slow, followed by falling prices. However, one must ask, what is falling, the value of the physical structures or the land itself? With material costs not significantly lower, it is land prices that are falling. And house builders who have been buying up land in huge quantities in the U.S. and the UK in particular are exposed to this reality. I expect land price writedowns to step up in earnest producing a second major home builder bust after Martinsa Fadesa in Spain. Where will it be? My best guess is the U.S. or the UK.

Stock markets will fall. When the summer is over and people have returned to work again, preliminary readings on Q3 earnings will start to take shape. The will not be good. Warnings will increase in September and earnings will be bad in October, precipitating a global sell off in share prices. The financial services, retail, hospitality and discretionary consumer sectors will be hit hardest.

So, that is my list of ten predictions — not all bad, but certainly not all cheery. I would not describe this as a muddle -through prediction. I see a muted, but long recession gathering hold in the developed economies with financial services fragility being a determining factor in limiting the upside until the end of 2009 or 2010 at the earliest.

Let’s see how events unfold.

Let’s take them one-by-one and see what the trend should be going forward.

Oil Price: Here I was on the money. Despite believing in peak oil, I did feel that demand would collapse and prices along with it. Oil did fall to $100 and went much lower. Now it is trading at $88. I don’t see it dropping much more from here, but that all depends on how robust the economy is going forward. At a minimum, we’ll see a nice little inflation dividend from this.
Inflation: On the money, again. My call was pretty much a no-brainer given the first call I made. Inflation will continue to fall. BUT, with credit contracting the question now is about DEFLATION, rather than inflation. I expect inflation to crater from here and deflation to be a serious possibility.
Fed Funds Rates: The deed is done. Now, I do think the central banks are doing their best to keep this thing from going pear-shaped, but I am not a believer in liquidity from lower interest rates as the solution. Low interest rates are the problem. But, expect more of the same going forward.
Bank failures: Lots of them. That one was easy. — or at least so I thought. The question now is whether we will see more major bankruptcies. I am not worried about Itty Bitty Bank, but about RBS, UBS, Fifth Third and so on. I do think that a major U.S. regional will bust by the end of Q2 2009. But, with the central bankers on the case, maybe the worst is over. At least we can hope.
U.S. GDP: It was way over 1% in contrast to the two previous quarters — almost unbelievably so. But Q3 was a bust and it could be negative. The U.S. is clearly in recession and I expect the GDP numbers to reflect this for both Q3 and Q4.
Stimulus: I think we got it. The Bailout package had a lot of tax cuts and other incentives attached. I certainly see this as a stimulus package and I expect more of the same in the first quarter of 209. On the other hand, the Europeans are going to be constrained from getting crazy like the U.S. The UK, Ireland and Spain will want to do what the U.S. has done, but they are in a fiscal straight jacket and will not do so in the same measure.
Recession in Europe: Unfortunately, yes. Italy, France, Germany, Ireland, Spain, and the UK are not looking good. Denmark saw a reprieve last quarter, but mat fall back into recession. One reason the Euro is weak is that Europe is weak and will continue to weaken going forward.
Recession in Britain: Yes! That’s a foregone conclusion. The question now is how deep. I say it will be deep. But the BoE and Labour Government actions today should mitigate some of the worst of it. I am cautiously optimistic about the UK.
Home Builder Bust: Only one so far – WCI. Will others go bust? Maybe. The UK, Spain and the U.S. are place
s to expect house builder problems.
Stock markets down: Way down! Global equity markets have gotten their clocks cleaned. It has been nasty and much worse than I expected. This has been a crash-like scenario that I did not foresee. Obviously, things unraveled rather quickly. At this juncture, all we can do is hope for the best. U.S. futures are predicting another massive selloff as I write this.

So as I see it, I am ten for ten now. Pretty good prognosticating. But, before I get giddy and start slapping myself on the back, I must admit that things are a bit more murky now. Once we see how the real economy reacts to the monetary and fiscal moves we have recently seen, we can determine how deep the global recession will be.

Look to Asia and BRIC (Brazil, Russia, India and China) to see what is going to happen next. If they have a hard landing – especially China, this will boomerang back toward the West and we will see another leg down in the Spring.

If they pull through, then we might see an economic bottom in the second half of 2009.