Friday, January 2, 2009
The Doomsayers Who Got It Right
--They used to be partypoopers, whose views were outlandish against ebullient stock market. Now some of their view are right in hindsight. --they freth government spending might result in a worse calamity --the foresee a treausry bubble in the forming --they see us consumers will reverse their consumption pattern, saving more --Jeremy sees the competitive currency devaluation which can heighten inflation risk. By JEFF D. OPDYKE For years, they were the party poopers: financial prognosticators who, amid the ebullient stock prices and effervescent home values that defined the early 21st century, warned of trouble. In hindsight, they're the ones who got it right -- or, at least, some of it. View Interactive How to Play the Crisis Even those spotting the trouble early don't agree how it will unfold -- or the right way to cash in. Often mocked for predictions that seemed outlandish at the time -- big banks will fail, Fannie Mae will go bankrupt -- a few of these outliers, including money manager Jeremy Grantham, mutual-fund manager Bob Rodriguez and brokerage-house owner Peter Schiff, were among the first to describe key parts of the U.S. financial meltdown. Still, they say the worst may be ahead. They weren't always entirely on the money. Mr. Schiff's main thesis, that the U.S. dollar will crash, hasn't panned out. Their views often are at odds with what economists generally expect. The consensus continues to predict a recovery in late 2009, with rising stocks leading up to that. Economists speak of a stronger dollar as the rest of the world struggles with recession. Bottom line: They expect the U.S. economy to lead the world out of the doldrums. Those who saw the crisis coming, on the other hand, fret that U.S. government spending on bailouts and stimulus plans that preserve failed business models could increase the likelihood of a worse calamity later. They foresee a long season in which consumers cut their spending, and instead sharply increase the savings rate. That would be healthy for savings-anemic U.S. households, which have spent beyond their means for years, but deeply problematic for a country where consumers drive 70% of all economic activity. They also envision higher taxes and the likelihood of further declines in U.S. stock prices as the Standard & Poor's 500-stock index bottoms out as much as 30% lower than today. And while noting that "deflation" is today's catchword, several experts say that inflation and perhaps even hyperinflation (in which prices rise at double- or triple-digit percentages) is the real issue a few years down the road as the Federal Reserve increases the money supply and relies on untested measures, such as buying home mortgages or other assets, to spur the economy. "It's all a grand experiment at this point, with no historical precedent," says Mr. Rodriguez, CEO at Los Angeles's First Pacific Advisors. Of course, Mr. Rodriguez and the others have been pessimists for many years, and even a broken clock is right twice a day. Here are their views for the future. Jeremy Grantham GMO LLC Jeremy Grantham: 'Competitive currency devaluation' could break out among nations. As early as 2000, Mr. Grantham, co-founder of Boston money-management shop GMO LLC, was warning his shareholders that "a sensational bust" was coming. That made him more than a half-decade premature. However, he notes that because the Federal Reserve cut interest rates to ward off the 9/11-inspired recession, the day of atonement was delayed. The government's fiscal actions after the 2001 terrorist attacks sparked "the greatest sucker rally in history," which, he predicted, would ultimately lead to a collapse of the financial system. By July 2007 he wrote that the real risk to the system would likely emerge in October 2008. He wrote that by the time the crisis passed, "at least one major bank will have failed." Surveying the wreckage today, he says that the unintended consequences of the government's response so far to the crisis are "unknowable. There is no playbook." For instance, he says "competitive currency devaluation" could break out among nations as each tries to boost its own economy by weakening its currency, possibly spurring similar moves by other nations fearful of losing any economic advantage. A weaker currency can boost exports (by making those goods cheaper abroad) but also heightens inflation risk. "With so many moving parts," he says, "you could easily have a surge of inflation." Treasury bonds, he says, are currently overpriced, "the 30-year ridiculously so." Bond prices move in the opposite direction as yields, and at current price levels, the 30-year bond is effectively forecasting little more than 1% annual inflation for the next three decades. "In your dreams," Mr. Grantham says. And while stocks have gotten hammered, he says, they're still not as cheap as they were in the 1974 and 1982 recessions. He gives it a "better than 50-50" chance that the S&P 500 falls further in 2009. He has set aside cash to invest in case stocks retreat to "a shockingly low number," he says, "like 600 on the S&P," which would be about 34% lower than 2008's closing value. His firm has waded back into a few emerging markets -- in particular, Turkey, Korea and Thailand -- because of cheap valuations. Mr. Grantham is worried the dollar could weaken, and foreign securities provide the potential for gains as foreign currencies potentially strengthen. Moreover, stocks overseas fell harder during the crisis and are now cheaper than in the U.S., he says. He expects that over the next seven years, real returns in emerging markets will be about 9.5% a year. Returns in the U.S. will be about 7.5% annually, he says. That's not a nightmare, but it is below what investors will reap outside the U.S. One domestic bright spot: franchise names like Coca-Cola Cos., Wal-Mart Stores Inc. and Microsoft Corp. should do better, he says. "The super-blue-chips are the most attractive part of the market anywhere in the world." Bob Rodriguez View Full Image Bloomberg News /Landov Bob Rodriguez: A 'massive bubble in Treasurys' appears to be forming. Mr. Rodriguez manages the FPA New Income fund, which was up more than 4% in 2008 due to some notable shifts in the investment strategy in recent years. He saw storm clouds gathering in 2005 when newly minted pools of supposedly high-quality "Alt-A" mortgages began acting oddly: Delinquencies and foreclosures were surging on mortgages just nine months old. (Alt-A mortgages, sometimes called "liar loans," were widely used by borrowers with high credit scores but undocumented income.) "We'd never seen that before," he says. He quickly dumped the holdings, reckoning that by the time he figured out what was actually going on, whatever disaster the odd behavior foreshadowed would have already occurred. Over the next few years he penned increasingly dour shareholder letters attacking every area of financial services. He stopped buying Fannie Mae and Freddie Mac debt and took giant insurer American International Group Inc. off the list of approved commercial-paper investments. He refused to invest in financial-services companies because of what he saw as "a pandemic collapse" in the rules by which lenders approved mortgages. As of 2004, he began moving his fund to more than 45% cash, even as one big shareholder yanked out $300 million because of his bearish stance. Looking forward, he, too, sees "a massive bubble in Treasurys" forming. "Quite frankly, we do not trust government," he says, as the U.S. government adds more debt to pay for economic-revival measures. He's not buying Treasurys because "We will not lend long-term money to a borrower that capriciously erodes its balance sheet." His real concern, he recently told shareholders, isn't the next two years, "but period three through 10." In an interview, he says it will be punctuated by inflation, and he expects real GDP growth of no more than 2% a year, possibly less. He also expects consumers to save rather than spend, spawning "severe difficulty for a large segment of the economy directly or indirectly related to consumers." By the time the March quarter ends, he expects the U.S. savings rate will approach 4%. By the first quarter 2010 it could be in the 7% to 10% range. In recent years, that rate has hovered near 1% or lower, indicative of a country binging rather than saving. In other words, Mr. Rodriguez doesn't think Americans will shop their way out of a recession. He believes the U.S. consumer has transformed into a saver, though policymakers don't fully understand that. President-elect Barack Obama "will try to stimulate spending with one foot on the gas, while consumers are pushing on the brake" by saving. "We're in for a very discontinuous environment." Thus, he says, the economy will sputter in fits and starts. The recession will deepen over the next six to 18 months. Still, for the first time in more than a year, he bought stocks as the crisis unfolded in October and November. Nearly 70% of those purchases, though, were in the energy sector, he says, because prices for real assets, such as a barrel of oil, tend to rise as inflation rises. Peter Schiff View Full Image Associated Press Peter Schiff: Foreigners could 'stop enabling us' by buying U.S. debt, hurting the dollar. Since at least 2004, as president and chief global strategist at EuroPacific Capital, a broker/dealer in Darien, Conn., Mr. Schiff has routinely peddled warnings that the housing market was a house of cards and that stock values were artificially inflated by Federal Reserve and White House policies that, he says, "were working against market forces." In a speech at the Western Regional Mortgage Brokers Conference in 2006, he essentially told the audience of mortgage bankers many would soon be unemployed due to a housing collapse. He noted as well that a recession could begin in December 2007 -- correct, according to the National Bureau of Economic Research. In his 2007 book "Crash Proof," he forecast the demise of Fannie Mae and Freddie Mac. Still, he has been wrong on significant parts of his argument. Many detractors point out that two of his core beliefs -- a longstanding prediction that the dollar would collapse and that foreign stocks would outperform U.S. shares -- have been well off the mark in this crisis. A rush into the safety of the greenback sent the dollar soaring against other currencies and, as a side effect, helped undermine shares of stocks around the world. Mr. Schiff acknowledges that he wasn't expecting that to happen. But he says his worries aren't misplaced: A dollar dive and foreign-stock outperformance are still in the cards. Looking ahead, Mr. Schiff foresees "massive inflation," and sharply higher interest rates, since the U.S. will have to entice foreign investors to buy the trillions of dollars in government-issued bonds that the U.S. needs to sell to pay for bailouts and stimulus plans. The quandary, though, is that at some point global investors will stop buying U.S. debt. "They will stop enabling us," he says, amid concerns about America's ability to repay the debts. "They will stop buying our bonds, our currency, and the value of the dollar will drop precipitously." Taxes, too, will have to rise, particularly on upper-income families, he says, because an economy based largely on consumption, not production, has few ways to generate the money needed to repay its debt when consumption is waning. He thinks there's time for government officials to limit the damage he says they are inflicting. But "if they're not careful," he says, "their actions are going to wipe out the value of savings in this country."