Ten predictions for 2008

With 2008 now half over, it’s obvious that the global economy has lurched to the downside. While many have remained unrealistically optimistic about the workout of the present credit crisis, downside risks have been the determining factors in keeping things soft.
Where are we headed?

I’d like to answer that question with my top ten predictions for the second half

1. 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.
2. 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.
3. 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.
4. 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.
5. 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.
6. 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.
7. 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.
8. 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.
9. 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.
10. 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.