Sunday, December 28, 2008

Private Client Commentary - Economic Outlook

Dear Clients,

If you would have told me fourteen months ago, when the Dow was at fourteen thousand, that we'd be sitting here today, shell-shocked by a bear market that took the popular index (at one point) down to 7,400+, I would have asked you what you been smoking.

Yet here we are, and based on the forecasts of many an economist, such as these two that were featured last week on, we're apparently staring into the abyss.

"The economy is in a bit of a free fall," says Nariman Behravesh, chief economist at Global Insight. Behravesh is among those who now expect the economy to contract as much as 5 percent on an annualized basis in the first quarter, followed by a small contraction in the second quarter. Global Insight's outlook assumes President-elect Barack Obama and Co. "do something big, bold and swift," explains Behravesh. "If they don't, then for sure this is the worst recession in the Cold War period."

Bank of America's chief economist Mickey Levy is forecasting a decline in every quarter of 2009 and doesn't see a return to trend, or normal, growth until early to mid 2010. "The enormous correction in housing will continue through next summer, accompanied by a rapid rise in unemployment and declining corporate profits," Levy says.

Either the doomsayers far outnumber the Pollyanna's when it comes to the current state of the economy, or the doomsday headlines simply sell more media. Nonetheless, you can't deny that the reality of the recent statistics supports the spirit of today's headlines. But another thing we can't deny is that even the doomsayers, like BofA's Levy (who is among the more pessimistic), forecast an ultimate end of the pain (early to mid 2010 in Levy's case).

Here are a couple of relatively optimistic (a little harder to find) outlooks also taken from CNBC's website:

"The recession will end sometime in the first quarter, followed by a not great-shakes recovery," says Ram Bhagavatula, managing director at Combinatorics Capital. "There's room for optimism. Both the Fed and Treasury have done a lot more than they usually do at this point in the cycle."

Housing Related Comment: Optimists point to relatively stable sales over the past year, declines in new and planned construction and the recent sharp drop in mortgage rates. "We are starting to find the critical elements to a housing bottom," says David Resler, chief economist at Nomura International, adding a late spring rebound in sales and prices is "not out of the question."

If indeed the problem began with housing, many believe that housing is the key to a sustainable economic recovery.

I've made it my practice lately to reference the comments of arguably the most successful investor of all time, Warren Buffet. Why? Because I find it fascinating that the greatest there's ever been, and currently the richest man on the planet, has done it by following the most basic fundamental rules of investing. When asked what his favorite holding period for stocks is, he says "forever".

Buffet told CNBC the following in August 2007 and repeatedly throughout 2008:

"We'll survive current and future recessions just as we've survived past problems. We've got a wonderful economy... There's never been anything like that in the history of the world. We live seven times better than the people did a century ago on average... We've had problems all along. If you look at the last century, we had that Great Depression and World War Two, we had the Cold War, we had the atomic bomb, but the country does well."

"Recessions will create opportunities. I made by far the best buys I've ever made in my lifetime in 1974. And that was a time of great pessimism and the oil shock and stagflation and all those sort of things. But stocks were cheap."

In October

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