Saturday, November 22, 2008

Into the Crystal Ball

After being to a few investment symposiums (one of the benefits of having the CFA charter) and doing my own overview of the markets, here are a few things I think are probable:

  1. Long term interest rates will go up significantly while short term rates will stay low (i.e. a very steep yield curve).   One of the reasons is because of all the debt the U.S. government will have to issue over the next few years.   Currently, the 30 year bond is yielding 3.66%.   Warren Buffett got 10% yield on his preferred interest on his investment in Goldman Sachs.   The Chinese, with their massive dollar reserves, will be financing this, like it or not.   They will not accept a 3.66% return on their money if Buffet is getting close to 10%.   The yield on a 30 year bond will be hitting 8% over the next year or so in order to pay for the TARP program and whatever else Congress dumps on us.
  2. If we are looking at a 8% 30 year bond rate, the stock market will drop to a level relative to this.   If we assume a 3% dividend yield (a bit on the hight side) to make the math earlier and a 30% risk premium, the S&P combined earnings and dividend yield (i.e.  dividend yield plus the inverse of P/E) should be roughly 13%.   That implies an earnings yield of 10% or a P/E of roughly 10.  S&P 500 earnings will likely drop by about 30%, so that gives an implied index level of 450 as the bottom - so a worse case scenario of a 40% + drop.   Mind you, that is a worse case scenario, but I can see it dropping down below 600.
  3. Commodity prices will continue on a short term downtrend, and will start back on an upward swing  once the markets start to recover from their bottom.
  4. There will be another major bank failure in the next year.


Hershblogger said...

I have not been able to account for the recent strength of the $US except that all the other currencies represent a worse risk. I have not been able to understand why big inflation can be ignored.

You seem to see this similarly, why hasn't the market reacted? It's not that far in the future.

Mitch said...

Part of the reason for the strength in the US dollar right now is that people are fleeing for U.S. Treasuries. It will weaken as more debt is issued, but not so much as to endanger it's role as the reserve currency. The Europeans are attempting to get he Euro to become the world's reserve currency. The problem is that their structural issues are much more acute than even the U.S.