Those of you who've regularly read my commentaries over the past year know that I've repeatedly warned investors that the U.S. economy would likely grow at a sluggish pace for a lengthy period of time.
However, I've never forecast an outright recession.
With Treasury Secretary Henry Paulson now proposing a $700 billion taxpayer bailout of financial institutions, I've changed my outlook. I'm now convinced that the U.S. economy will fall into a recession by the first quarter of 2009.
In other words, I expect the employment situation to continue to deteriorate, U.S. businesses to continue to reduce their investments in capital assets, and for retailers to experience declines in their sales of automobiles, household appliances, clothing, and numerous other consumer goods. In simpler terms, I expect the total output of goods and services — the U.S. gross domestic product (GDP) — to decline during the months ahead.
Economic conditions in the United States have progressively deteriorated over the past two years. Industrial output at the nation's factories, mines, and utilities has declined (on a year-over-year basis) during each of the past two months, and retail sales have fallen during each of the past eight months. Meanwhile, employers in the non-farm sector of the economy have reduced their workforce during every month since the beginning of 2008. In other words, the U.S. economy is probably already in a recession, as National Bureau of Economic Research (NBER) defines it.
Yet, many of the so-called Wall Street "experts" — mutual fund portfolio managers, financial economists, and other stock market pundits — continue to claim that the economy isn't in a recession and that economic conditions in the U.S. will soon rebound. Those same experts repeatedly told investors over the past 12 months to add to their stock portfolios because, according to them, stocks were (and still are) "cheap." Those so-called experts also have repeatedly claimed that over the long-term, stock prices always appreciate.
Yet, stock prices as represented by the S&P 500 Index have fallen 20 percent over the past year and have returned only 3.78 percent per year, on average, over the past decade. After accounting for the effects of inflation, a broadly diversified portfolio of stocks (as represented by the S&P 500 Index) returned a mere 0.78 percent per year from Sept. 19, 1998 to Sept. 19, 2008. In other words, a person who followed the advice generally rendered by the so-called Wall Street experts would have experienced virtually no appreciation in his or her portfolio over the past 10 years.
Specifically, $10,000 invested in an S&P 500 Index fund would have grown to only $10,800 in inflation-adjusted dollars over the past decade.
Now, most of those same experts agree with Treasury Secretary Henry Paulson's proposed bailout of irresponsible investment-banking firms. Meanwhile, many of our so-called government representatives — members of the U.S. Congress — are asking taxpayers to bail out irresponsible persons who signed mortgages to buy homes that they couldn't afford.
If Congress approves Paulson's bailout plan, there's a good chance that the U.S. budget deficit will grow to at least $1 trillion over the next couple of years (or 7 percent of the U.S. GDP), and that U.S. government debt will rise to 70 percent of GDP — the highest level since 1954 when the nation was still paying down costs incurred from World War II and the Korean War.
In essence, every U.S. citizen could end up owing the government $37,000, on average, to pay for Mr. Paulson's proposed bailout of private financial institutions. That's a fairly hefty bill, considering that the median income for U.S. citizens was approximately $50,000 in 2007.
Don't forget about the costs to bail out Bear Stearns, which cost taxpayers an estimated $29 billion, and the government takeover of Fannie Mae and Freddie Mac, which has already cost taxpayers approximately $200 billion.
In addition to those bailouts, the Treasury Department has proposed the establishment of a $400 billion Federal Deposit Insurance Corporation fund to insure investors in money-market funds.
Meanwhile, the wars in Iraq and Afghanistan cost taxpayers approximately $16 billion per month, and U.S. automakers recently asked the government — that is, the taxpayers — to provide them with $50 billion in low-interest loans over three years to modernize their assembly plants.
Well, guess what the outcome of those bailouts is going to be! You got it — a swelling of the U.S. budget deficit, higher taxes, and a substantial rise in long-term borrowing costs. So, you might as well forget about Barack Obama's massive government spending proposals, John McCain's promised tax cuts, and a near-term end to the downturn in the U.S. economy.
Rather than helping to stimulate the U.S. economy, my research indicates that the bailouts will lead to a significant increase in long-term borrowing costs over the next few years. If foreign investors were to lose faith in the U.S.'s ability to repay its loans on a timely basis, long-term interest rates could skyrocket as investors would likely demand much higher returns on their loans to the U.S. government.
Meanwhile, the government will likely be forced to raise both corporate and individual tax rates to pay off the loans. With U.S. consumers already highly in debt, and the employment situation continuing to deteriorate, my research indicates that consumers will therefore significantly rein in their spending during the months ahead. That's a very worrisome concern, because consumer spending accounts for approximately 70 percent of the United States' total output of goods and services (GDP).
If consumer spending does continue to decline, I expect U.S. business to continue to reduce investments in manufacturing facilities. That's also a big concern, because business fixed investments are another major component of GDP.
Although U.S. exports enabled the U.S. economy to expand during each of the past three quarters, I also expect that trend to reverse course during the months ahead, as most leading economic indicators for European and Asian countries indicate that economic growth will slow considerably in those countries over the next couple of quarters.
What Should Investors Do?
In light of the factors discussed above, I urge you to ignore most of the so-called Wall Street "experts." Keep in mind that those money managers' salaries and bonuses are directly tied to the amount of money that they manage for investors. In other words, those money managers have an inherent interest in trying to persuade investors to add to their investment portfolios.
Although I expect the Congress to soon approve Henry Paulson's proposed bailout of financial institutions and for stock prices in general to rally sharply once such a plan is approved, the path of least resistance for stocks over the long term is down.
By the way, if you think I might be one of those perennial "gloom and doomers," think again. From November 2002 through June 2007, I was strongly in the bullish camp.
Current subscribers who followed my advice to buy an inverse-oil and gas ETF on May 23 of this year, and to sell that fund on Aug. 12, realized a 31 percent return on their investment when the so-called Wall Street experts were forecasting oil prices to rise to at least $150 per barrel by the end of this year. With stock prices now trending lower, those same subscribers are making money in an inverse-consumer services ETF that I recommended on Aug. 7.
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