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The Economy: Long Illness, Long Recovery


Patience, fortitude will be necessary.

The Right Direction, At Least

Over the last year, I've become increasingly more bearish on the economy than I was in January of 2007. In my 2007 annual forecast issue, I said that we'd be in a recession by the end of the year (we were). And though it would be long, it woudn't be too deep, but would include a multi-year below-trend Muddle Through period to follow. I thought GDP would maybe be down 2-3%.

As I've repeatedly written in this letter and said in speeches, the US stock market drops by an average of 43% in recessions. I saw no reason to be in the stock market, as there was just too much risk of a serious bear market. Further, since international markets now have close to a full correlation with the US markets, foreign stock indexes would be in trouble as well. I also said interest rates would be coming down and deflation would be a problem before we got through this recession.

(As an aside, there are a lot of very well-known perma-bearish analysts who called the recession, but were very bearish on the US dollar and positioned their clients in emerging-market stocks or other markets. Their clients have been mauled. Just because you get the economy call right doesn't necessarily mean you can call the right investment shots. Before you invest with managers because they seem to have been right about something, look to see what their actual investment strategy has done. And that includes me or my partners.)

I also predicted the bursting of the housing bubble and the subprime credit crisis in late 2006 and 2007. While I was completely wrong about the severity of the current recession, at least I got the direction right. My advice would've been the same, which was: Avoid long-only stock portfolios and mutual funds, be long bonds, and access active, absolute-return managers and funds.

But the facts have changed. The reality is that we're in a much worse recession than I thought it would be 2 years ago. And as I wrote last month, we'll probably be in recession for the full calendar year 2009, with the same lengthy multi-year Muddle Through Economy I originally envisioned, albeit from a lower base. So, what does that look like? Let's look at a likely set of facts, in no particular order.

1. Consumers are going to save more and spend less. It's likely that US consumers are going to push the savings rate back up to 6% (or more). Total US net worth decreased by $7.1 trillion through the third quarter of 2008, from housing and stock market losses. The trend suggests that could easily be up another $6-7 trillion by the end of this quarter. Greg Weldon speculates that is could easily be $15 trillion by the end of the cycle. That's a massive amount of wealth destruction. And while the absolute numbers are not as large in the rest of the world, the relative magnitudes are. Economists say that anything below 2.5% in world growth is a global recession. We're down to 0.5% and falling.
No positions in stocks mentioned.

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