Financial Physician’s 2010 Forecast

Financial Physician’s 2010 Economic and Financial Market Forercast

Lou Scatigna

 2009 review

Although 2009 started off with an economy in free fall and panic in the financial markets, from March on the economy seemed to stabilize and the stock market rebounded in historic fashion.

The Dow, S&P 500 and Nasdaq finished the year up 18.8%, 23.45% and 44.89% respectively.

The Federal Reserve embarked on an policy of stimulation and quantitative easing (money creation). The mortgage, treasury bond, and stock market were all beneficiaries of the Fed’s record stimulus. The Fed bought over $800 billion in mortgage securities, $300 billion in Treasuries and it’s anyone’s guess how much Fed money found it’s way into the stock market thorough The Primary Dealer Credit Facility. Under this program the Fed allowed Primary Dealers (Goldman Sachs, JP Morgan etc.) to use common stock as collateral for low to no interest loans. It looks like the dealers took advantage of such juicy terms to buy stock, use it for collateral, buy more stock use it for collateral etc. The Fed subsidized buying rallied the stock market over 60% from the March lows, but was the rise in the market justified by economic fundamentals?

The Federal Reserve has recently stated that many of these stimulus programs will end the first half of 2010, and with them a huge source of market liquidity.

Although 2009 did not turn out to be the end of the financial world as we know it, but it just may have been delayed to 2010. The coming year will be a challenging one and in my opinion the worst year so far in the worst financial crisis since the Great Depression. For most of 2009 we were in the eye of the financial storm, the backend of the storm is about to hit us in the months ahead.

My forecast for 2010 is a dire one, filled with increased volatility, financial instability, shortages of basic items and rising number of bank failures. As I have said each of the last two years, I hope my forecast is 100% wrong, because if I’m right, much pain lies ahead.

The Financial Physician’s 2010 Economic and Financial Market Forecast

 Economy:

The economy during the first half of 2010 looks to be relatively stable. Although unemployment will continue to rise, the reported GDP will grow about 2% in the first quarter and 1% in the second quarter. Inventory draw downs and trickle down stimulus will prevent the economy from falling off the cliff during the first half of 2010, the second half is a different story.

Continued tightness in credit markets will put a crimp in corporate investment and retail sales. Credit card delinquencies are over 10% and credit card companies have cut back credit lines drastically. Those that still have room on their credit lines will avoid using them due to the outrageous interest rates being charged on existing balances. Home equity lines of credit are virtually non-existent as most homeowners have little if any equity in their homes.

Commercial real estate loans will fail by the billions and banks will be under sever financial stress like they were in late 2007. An economy without free flowing credit cannot grow. The U.S. economy will decline during the second half of 2010. Third quarter GDP will be minus 3 and forth quarter will hit -4.

Unemployment will continue to increase throughout 2010 with the unemployment rate topping 12% before year end. When discouraged and part time workers are included, the unemployment rate will top 20%, truly depression era numbers. The high unemployment rate will frighten existing workers who will cut back spending and begin to save all they can, fearful that they too may find themselves without a job.

Housing prices will continue to fall in 2010 as millions of mortgage interest rates are reset during 2010 resulting in more record foreclosures. Rising interest rates will also restrain housing as 30 year fixed rate mortgages rise throughout the year ending at 6.5%. (currently 5). The expiration of the tax credit will also turn housing prices south the second half of 2010. I expect housing prices to drop another 15% in 2010, hitting a generation bottom late 2010 or early 2011.

By September economists will have changed their tune from “the recession is over” to the “Depression of 2010″ has begun.

Treasury Bond prices will fall dramatically in 2010 as the incredible bubble in bonds pop with a vengeance. The U.S. budget deficit is expected be at least $1.5 trillion in 2010 , couple that with the fact that over $2 trillion in existing bonds are maturing and must be rolled over and you have a Treasury that needs to borrow a gargantuan $3.5 trillion in 2010. Foreign buyers have been cutting back their appetite for our debt and may even become net sellers of U.S. bonds in 2010. The Federal Reserve will be forced to buy an ever increasing amount of U.S. debt and will do it via the electronic printing press.

The only other way to entice foreign purchases of U.S. debt is to have yields rise dramatically, something the Fed does not want as it will be a spear in the heart of the U.S. economy. The U.S. Treasury market will be a dangerous place in 2010 as 10 year yields rise from 3.8% today to 5.25% (or greater) by the end of 2010.

The U.S. Dollar will be the big story in 2010 as it loses substantial value against both foreign currencies and gold and silver. The extent of the Fed’s Quantitative Easing (printing money) and monetization of our debt (buying treasury securities with said printed money) will rile investors both domestic and foreign. The devaluation of the dollar will be swift and frightening during mid-late 2010. I expect the dollar index to fall to 62 (currently 78). The result will be a plunging U.S. bond market and rapidly appreciating tangible assets like oil and gold.

Gold will resume it’s historic rise against the U.S. Dollar as well as all other currencies being debased. Gold (currently $1,097) will exceed $1,350 in 2010. If the decline in the U.S. dollar becomes disorderly than $1,500-$2,000 would not be surprising. Shortages of physical gold will be experienced worldwide as investors try to protect themselves from plunging fiat (no gold backed) currencies. Mints will regularly run out of bullion coins as the supply of blanks dries up. Investors will also be competing with central banks eager to divest out of dollars. China, Russia, India and middle Eastern countries have made it known they want increase their gold positions. Mine production has been falling in recent years adding to the bullish supply-demand equation.

Silver (currently $16.85) will rise to $25 in 2010 and possibly much higher in a currency crisis.

Oil prices will range from a low of $62 the first half of 2010 and exceed $100 a barrel in the fall as inflation accelerates in the face of a falling dollar. Gasoline prices will range from $2.25 to $3.70 in 2010.

Inflation will remain relatively muted the first half of 2010. Although we may see a rise in energy and food prices, slack demand will keep general inflation at bay the first half of 2010. Inflation will begin to rise during the second half of 2010 in response to a rapidly falling dollar. The monthly CPI will exceed 6% by the end of 2010, rapidly accelerating into dreaded hyper-inflation in 2011. As inflationary expectations rise, people will begin to hoard food and energy items resulting in skyrocketing demand and dwindling supplies. Look for shortages of food and energy in late  2010. Food shortages will result in looting and civil unrest. There will be large demonstrations both locally and in Washington as the people become more fearful of their economic survival. Food shortages in poor and developing nations will be much worse than that experienced in the western world.

Stock Market

This forecast has been the most difficult one for me to nail down for the following reasons: A. I have no idea how much the market will be manipulated through quantitative easing and market manipulation. 2009’s 60% rise happened largely because the Fed made the funds available to the primary dealers who then bought the market (making billions in the rigged game). B. I’m not sure what the market will do during an inflationary spike in late 2010. Historically stocks tend to perform well during inflationary periods.

So with these variables in mind, here is my forecast for the U.S. stock market in 2010. The market moves about 10% higher from current prices before correcting hard to the downside. Stock prices will fall about 30% from current prices to 7,280 on the Dow and 784 on the S&P 500. If these levels don’t hold then a test of the March 2009 lows would be in order (6,500 Dow and 666 on the S&P). If those levels do not hold we are in for a very scary time in America. Late 2009 will witness an inflation induced mild rebound but the market will end down over 20% for the year.

Financial Institution Failures

In my 2009 forecast I thought over 300 banks would fail but only 140 were closed by the FDIC. If the FDIC had the manpower and enough money in the insurance fund I am sure at least 300 banks would have been closed in 2009. The FDIC has almost doubled it’s staff in anticipation of a rising number of bank failures in 2010. I expect over 500 banks to be closed by the FDIC in 2010 (I may be way too low on this number) Banks were just assessed three years of insurance premiums raising $45 billion for the insurance fund. The Fund was about $15 billion in the red at years end so the $45 billion in three year assessments is down to $30 billion. I expect the $30 billion to be gone by the end of June. What will the FDIC do then? Banks have already paid assessments for the next three years so where is the money going to come from? You and Me, that’s where. The FDIC will begin to tap the $500 billion credit line it has with the U.S. Treasury. This money will have to be borrowed be adding to the already impossible $3.5 trillion in 2010 borrowing needs. There will be some minor runs on banks when the FDIC runs out of money and has to hit up the Treasury. I don’t rule out a “bank holiday” if things begin to get ugly next fall. God help us if that happens.

I expect at least one major insurance company to hit the wall this year. Insurance companies are flush with toxic commercial mortgage debt. Hartford insurance had to borrow $3.5 billion from the TARP in 2009 to stay solvent. There will be more bailouts ahead for the insurance industry.

The first batch of pensions may begin to default in 2010. I fear retirees will be receiving letters in the mail notifying them that their pension checks are being drastically reduced. This coupled with rising inflation may impoverish a vast number of seniors citizens. The Pension Benefit Guarantee Corp, the federal institution guaranteeing pensions, is in the same boat as the FDIC, running on fumes and in need of a government bailout.

Default of States and Municipalities

At least one state (and most likely more) will be insolvent in 2010. California and New York look to lead the parade. Municipal bond prices will plunge as states and cities default on interest payments. State and city services will be drastically cut and crime will rise. States will beg Washington for bailouts and will most likely receive some assistance (for a price) but it will be inadequate.

Geopolitical Concerns

Geopolitical issues could significantly affect the economy and financial markets in 2010. The number one concern is Iran’s quest for nuclear weapons. Israel has made it clear that they can not live with a nuclear Iran and will take action by mid 2010 if no deal is reached. An attack on Iran would throw the world into chaos. Oil prices would go to triple digits, stock markets would plunge and gold and silver would fly.

Another big geopolitical risk is the instability of Pakistan. The insurgents are gaining more influence in Pakistan and any attack against Pakistan’s nuclear arsenal would bring in U.S. action. The safety of Pakistan’s nukes is the most pressing issue in regards to world security.

Al Qaida has made it clear it is ready and prepared to launch terrorist attacks worldwide. The attempted terrorist attack against a U.S. airliner this past Christmas Day is a reminder that the world is a very dangerous place. A 9/11 type of attack on Europe or the U.S. would plunge the world economy into depression and the terrorist know it and want it. Let’s pray that 2010 does not witness a massive terrorist attack.

I’m sorry to depress you with such a negative economic and financial forecast. I wish I could have a better view of the coming year but unfortunately I do not. Many economists and financial forecasters are much more optimistic than I, but I have been in the minority for the last three years. Once again I hope I’m wrong and they are right. It makes sense to protect yourself as best as possible, keep your risk exposure low, stay within FDIC insurance limits ($250,000), have some gold and silver in your portfolio and spend money wisely in 2010.

One thing I know for certain, 2010 is going to be an very interesting year.