My predictions for 2008
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It’s the time of year for financial columnists to stick their neck out. So here goes…
“Don’t tell me when I will die,” says Woody Allen, “Just tell me where. I’ll avoid the place.”
In the year of our Lord 2008, there will be many places where investors’ money will die. Of course, if we knew where the deaths would take place we wouldn’t be writing this column.
But this is the time of year when a financial columnist lets his well-deserved humility give way to brazen immodesty. He sticks his neck out – and offers MoneyWeek readers a peek at the upcoming year’s financial obituaries.
But let us add an extenuating circumstance: the importance of an event is not merely its likelihood – but the likelihood times the consequences. For example, it is not a good idea to drink heavily then drive to Brighton. Most likely, you’ll get there in any case – but the consequences of being wrong make it a bad choice.
Likewise, we may have another year of rising equity prices, a strong currency, a new boom in house prices and a healthy, growing economy. But there are times – such as after imbibing too deeply for too long from the cup of liquidity – when betting on rising asset prices and prosperity is a bad wager; the risk of a crack-up is just too great to ignore.
So let us turn to our guesses. The alert reader will see that they follow a pattern. We believe the financial world stands between two more or less equal and opposite forces. On one hand is the irresistible force of inflation. On the other is the immovable object of deflation. Central bankers are trying to keep prices rising on one side; on the other, Mr. Market has plans of his own.
The party is over, says the market. No, here’s more punch, say the central banks. And just to complicate things, between the thesis of inflation and the antithesis of recession is the synthesis of stagflation. Not that we know what will happen, but with all this ‘flation’ around, something is bound to blow up.
Our guess is that this will be a better time to sell shares than to buy them. The UK economy depends on two big industries, and both are menaced by ‘flation’. Britain depends on the City. The City takes money from the people who earn it, all over the world, and brings it into the UK economy. It’s also responsible for stirring the pot of share prices. When credit contracts, the City stops stirring so hard.
Another problem is the housing industry. Houses aren’t going up; they’re going down. In Britain, as in America, falling house prices squeeze homeowners and cut consumer spending. When consumers don’t spend, businesses don’t earn as much. Falling earnings produce falling share prices and an economic slump.
There are two things you can count on: house prices and business earnings revert to the mean. Housing prices always go back to levels where people can afford them. And outstanding earnings always get worn down by competition. The pound, too, is threatened by both inflation and deflation. The former hurts the value of the pound directly. The latter, by reducing revenues to the financial industry and lowering house prices, hits it hard too.
If we were writing a life insurance policy on it, we’d want a thorough physical. What threatens sterling most immediately is that its caretakers are so eager to see it pass away. The Bank of England, along with the European Central Bank and the US Federal Reserve, are all working the pumps – trying to keep the inflationary boom going by reducing the values of their own currencies. We have little faith in the healing power of central banking; but when it comes to killing a patient, even a quack can do the job.
But if the pound is to go down, what will it go down against? Good question. Against commodities? Maybe. Against housing and shares, as we have said, probably not. Against the dollar or the euro? We can’t say; they are all in jeopardy. Against gold? Back in January 2001, we announced our Trade of the Decade – sell shares/buy gold.
At the time, the ratio of share prices to gold was just coming off an all-time high of 44 ounces to one Dow index. Gold had scarcely ever been lower and shares had scarcely ever been higher. Twenty years previously, the ratio had been as low as 1 to 1. Since January 2001, the ratio of shares to gold has fallen in half. Not because shares have come down, but because gold has gone up.
The trade has been a good one. Will it be good in the year ahead? Again, we can’t say. But since we’re guessing, our guess is that there is more juice in this trade. Gold is clearly in a bull market. If the force of inflation prevails, it is impossible that the bull market will come to an end with the price lower than the peak set 27 years ago. And, if gold does not go up, it will be because the force of deflation has the upper hand, which will almost certainly mean lower share prices. One way or another, the Trade of the Decade still looks like a good one. Like a good marriage or a bad movie, we’ll stick with it to see how it turns out.
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