By Ron Brounes
Contributing Writer
Money Morning

With the U.S. credit markets in lockdown mode, a whipsaw stock market that keeps anyone from getting too comfortable, a banking sector in chaos and a recession that clearly won’t be ending any time soon, U.S. dealmakers are looking at a market for mergers and acquisitions that’s in a virtual deep freeze.

And don’t expect that market to thaw out anytime soon. Even with the country’s energetic new president, Barack Obama, now ensconced in the White House, consumer and business confidence is virtually non-existent and worries continue to churn that the U.S. banking sector would endure a complete meltdown.

The bottom line: The M&A market has all but disappeared.

“Beyond ‘almost none,’ there is really no story at all,” said Ryan Krueger, founder and Senior Portfolio Manager of Krueger & Catalano Capital Partners LLC, a Houston-based money management firm and a hedge fund manager collectively managing more than $150 million in assets.  “With credit markets frozen, there is no M&A. Or, at least, very little.”

 Krueger takes a more optimistic tone about opportunities that may present themselves in the future (if not already) based on lower valuations, but believes the timetable on deals could be rather lengthy as would-be buyers feel no need to rush into transactions at this time. 

“I [recently] sat down with a banker who pitched me on a company where I could pay 30 cents on the dollar for their cash alone,” said Krueger.  “I also looked at a gold mining company with proven reserves whose share prices are so low that you could buy the entire company for a little more than $400 an ounce for their gold.  Remember, without a ticker symbol attached, gold is fetching more than $800.  There are already some amazing stories and deals to be found.  Patient acquirers with cash will truly benefit.” 

Let the Good Times Roll?

Following a stellar 2007 – a year in which global deal volume reached $4.5 trillion – 2008 started out with a lot of promise. Sure, certain segments of the economy were showing some of the ill effects of the housing collapse. And the dreaded “I” word – inflation – had crept into many water cooler conversations as oil prices pushed past the $100 a barrel level.  Still, cash-rich companies seemed prepared to take advantage of distressed situations, as valuations began to look more attractive following a negative 2007 fourth quarter for stocks.

“Early in the year, companies were in acquisition mode as much of the economy appeared vibrant and business prospects for the future were bright,” said transactions expert Steve Albert, a partner with UHY Advisors Inc., the twelfth-largest accounting firm in the United States, and a member of the executive committee of the firm’s Texas practice.  “As details of Candidate Obama’s tax plan made their way onto the campaign trail [last year], people began to see the prospect of higher capital gains taxes for 2009 as a real possibility.

“Sellers of businesses had hoped to close transactions before the end of 2008 to take advantage of lower capital gains before new higher rates took effect in the following year,” Albert added. “This incentive quickly dissipated with the sudden downturn in the economy in the fall. The financial crisis that emerged reversed the sentiment that President-elect Obama would raise capital gains taxes as now unlikely since his plate would be full dealing with all these other national economic issues.” 

The expected follow-through in M&A activity from 2007 never materialized as the credit crunch turned into a credit crisis, which then turned into an outright credit collapse.

Through mid-November, Thomson Reuters Corp. (TRI) reported that deal volume had declined more than 30% from the 2007 levels. In fact, the reduction would have been even greater had it not been for a rash of transactions involving financial institutions – with three of the biggest getting finalized right as 2008 came to a close.

Bank of America Corp. (BAC) purchased one-time behemoth Merrill Lynch & Co. Inc. for about $24 billion, although the deal was initially priced at about $50 billion before BofA’s share price underwent a drastic decline. In the other two other deals, Wells Fargo & Co. (WFC) acquired Wachovia Bank for $15.1 billion and PNC Financial Services (PNC) bought Cleveland’s National City Corp. for $5.52 billion, in moves that allowed the acquiring institutions to receive sizable tax breaks from the losses they were assuming. 

The federal government’s bailout initiative – the Troubled Assets Relief Program (TARP) – also led to additional acquisitions of ailing financial companies. In early December, Capital One Financial Corp. (COF) announced its intent to purchase Maryland-based Chevy Chase Bank FSB for $520 million, and a number of life insurance companies looked to acquire small thrifts in order to access some of the TARP money. 

According to Bloomberg News data, the world governments had a major hand in more than one-third of the largest deals of the fourth quarter.

The Ones that Got Away

In reality, 2008 will be known more for the “deals that weren’t” than the “deals that were.” According to data from UBS AG (UBS), almost one-third of all transactions that had been announced in 2008 never closed because funding failed to materialize, valuations plunged after the initial announcements, or buyers simply got cold feet in this challenging environment. 

“Completion risk is on everyone’s mind,” claimed Cary Kochman who co-manages M&A for the Americas at UBS. “We are, on a historical perspective, amid the lowest level of deal completion.” 

While the proposed $45-plus billion acquisition of Yahoo! Inc. (YHOO) by Microsoft Corp. (MSFT) went sour due to founder ego, greed and internal shareholder disputes, other significant transactions were scrapped because of credit concerns and weak economic conditions.

Historically, M&A activity has declined during recessionary times. That makes intuitive sense as companies avoid taking on much additional risk, regardless of the attractive valuations.

Examples abound this time around. For instance, BHP Billiton Ltd. (ADR: BHP), the largest mining company in the world and the subject of a recent “Buy, Sell or Hold” story here in Money Morning, walked away from its $66 billion offer for Rio Tinto Group (ADR: RTP).  Likewise, Canadian telephone giant, BCE Inc. (BCE), was unable to complete its $42 billion sale to a private equity consortium. 

Looking Ahead

Many experts expect the declining level of M&A activity to continue through this year – and perhaps even beyond. Barclays Capital Group (PGD) expects deal valuations in 2009 to fall by another 30% to about $2 trillion, levels not seen since 2005.

Barclays acquired the investment banking arm of Lehman Brothers Holdings Inc. (LEHMQ) after the firm declared bankruptcy in September, a development that turned out to be a major catalyst for the current credit crisis and equity market collapse.

According to the Bernstein Research arm of Alliance Bernstein Holding LP (AB), M&A volume will fall by another 25% this year with a total drop-off in activity of 45% from peaks levels in 2007 to 2010.

Even so, Bernstein expects that counter-cyclical industries such as healthcare may see a flurry of activity, as cash-rich companies seek to take advantage of their struggling competitors. 

Larry Slaughter, co-head of European M&A for JPMorgan Chase & Co (JPM), believes that most of the deals that do close here in the New Year will be smaller, since the credit markets remain sluggish despite the coordinated government efforts to stimulate lending.

“You are less likely to see deal sizes beyond the $20 billion mark in 2009,” Slaughter said.  “The balance-sheet capacity of the banking system will make it tough to finance much-bigger transactions.”

UHY’s Albert believes we are in a buyer’s market and that companies that are flush with cash may be able to gobble up the ones that find themselves struggling or in distressed situations.

“In the spring of 2008, transactions were being priced at multiples of 8 [times] to 10 times earnings or cash flow,” Albert said. “Suddenly, after the downturn, multiples are more in the neighborhood of 3 to 4 and sellers are, quite frankly, not very excited about the new valuations.”

According to Albert, “with no access to the credit markets, many companies will not be able to finance their transactions – this situation will create a huge advantage for firms that have maintained substantial cash stockpiles on their balance sheets and would be able to consummate deals without having to access the credit markets. Typical companies included in this group with large amounts of cash are Exxon [Mobil Corp.] (XOM) and Microsoft and such corporations could prove to be winners in the current environment in terms of buying up undervalued firms.” 

UHY’s Albert sees opportunities for acquisitions within the energy sector, as struggling smaller companies face additional stress with oil trading in the neighborhood of $42 a barrel, meaning they won’t be able to financially justify drilling activities with crude prices so low.

Albert also noted that a talk of a higher capital gains tax could resurface, should the Obama administration economic plan begin to stimulate growth this year, meaning companies would have incentives to close deals before the new tax rates take effect.

Predicting M&A in 2009

Albert also believes that large companies may look to sell off non-core businesses or even international arms as they streamline and downsize operations.

“More than ever, management must play to their strengths and some may look to unload non-critical operations, particularly those that require substantial cash flow to manage,” Albert said.

Krueger & Catalano’s Krueger suggests that the current challenges will create future opportunities.

“As a result of the deepest most violent collapse in asset prices of all flavors, we are now planting the seeds for future deals,” Krueger said.

By dropping interest rates to historically low levels, he said that the government is practically begging investors to consider mergers and acquisitions again.

“Bottom line, capital will seek a return and risky assets like businesses will look better and better as long as risk-free Treasuries promise less and less in return,” he said.

Of note, Krueger believes companies that possess hard assets represent unusually good values in this environment.

“Materials companies catch my eye for many reasons and I am looking in some cases at multiples of 2 or 3 times cash flow and very little debt,” he said. “A related industry that serves many of these companies is engineering where we are finding backlogs of signed contracts whose value is more than three times the total value of every single share of its stock.  Potential acquirers may find attractive valuations here, especially since the Obama stimulus plan focuses on infrastructure enhancements.”   

Would-be buyers also may emerge from abroad as foreign companies attempt to take advantage of the domestic challenges and enter the United States’ marketplace in various industries. Recently, Electricite’ de France SA offered $4.5 billion for a chunk of the nuclear power business of Constellation Energy Group Inc. (CEG), outbidding a unit of Warren Buffett’s Berkshire Hathaway Inc. (BRK.A, BRK.B) in the process. Completion of the deal will enable the French company to participate in the U.S. nuclear industry. Regulatory issues may be drawing out completion of the Constellation nuke group buyout.

Richard Griffiths, director of the Hong Kong-based M&A unit of the Royal Bank of Scotland Group PLC (ADR: RBS) thinks that China and Japan may emerge as significant M&A players this year.

“Japan is likely to continue to [figure] highly in outbound M&A, as it benefits from a lower cost of borrowing and a stronger yen,” said Griffiths. “China remains a key draw for investors and a source of outbound M&A.”

Perhaps Krueger summed up the situation best with the following analogy.

“Mergers and acquisitions right now to me look a lot like my four- and six-year-old kids on the top step of our monkey bars in the backyard,” he said. “They are looking at each other with an unusual combination of smiling mouths and terrified eyes. Neither is going to move an inch until they see the other one flinch and then I have to run over there because they’ll move so fast to grab the same bars they’ll collide.”  

In other words, the same financial crisis that froze the M&A business will ultimately set the stage for the next round of dealmaking to flourish.

[Editor's Note: The writer of this installment of "Outlook 2009," Ron Brounes, is a regular contributor to Money Morning. A technical financial writer, Brounes, a CPA, is president of Brounes & Associates, a Houston, Tex.-based consulting firm that provides writing, communications, and educational services for financial services professionals.

As this story on the U.S. dealmaking market underscores, uncertainty will continue to be the watchword for at least the first part of the New Year. That's really no surprise, given that the global financial crisis continues to whipsaw the U.S. financial markets in a manner that hasn't been seen since the Great Depression.

It's almost enough to make you surrender.

But what if you knew, ahead of time, what marketplace changes to expect? Then you'd be in the driver's seat - right? You'd know what to anticipate, could craft a profit strategy to follow, and could then just sit back, watching and waiting - and finally profiting from the very marketplace events you anticipated.

R. Shah Gilani - a retired hedge fund manager and a nationally known expert on the U.S. credit crisis - has predicted five key financial crisis "aftershocks" that he says will create substantial profit opportunities for investors who know just what these aftershocks are, and how to play them. In the Trigger Event Strategist, the aftershocks actually create these so-called "trigger events," which then serve as gateways to massive profits. To find out all about these five financial-crisis aftershocks, and about the trigger-event profit strategy they feed into, check out our latest report.]

News and Related Story Links:

• Money Morning News Analysis:
  Bank of America, Wells Fargo and PNC End 2008 by Closing Major Buyout Deals.

• Reuters:
  Capital One to buy Chevy Chase Bank for $520 mln.

• Money Morning:
  Buy, Sell or Hold: Mine Profits From BHP Billiton.

• Money Morning News Analysis:
  The Obama Blueprint for Solving the U.S. Financial Crisis.

• Bizjournals.com:
  PSC still reviewing authority over Constellation deal.

• Money Morning Outlook 2009 Economic Forecasting Series:
  Money Morning Outlook 2009: Obamanomics Offers Investors Plenty of Profit Plays in the New Year.

By Mike Caggeso
Associate Editor
Money Morning

In a surprise to many, India’s central bank has cut its base-lending rate four times since October, going from 9% to its current rate of 5.5%. After all, isn’t India’s economy growing nearly as fast as China’s? And isn’t that growth already being fueled by an unprecedented level of middle-class spending?

The answer to both questions is a resounding “yes.”

But there’s a pesky asterisk here – and that’s the global financial crisis, the cash drought that has sapped nearly every country directly through their banking systems, or indirectly through fluctuations in exchange rates and gyrations in revenue received from key trading partners.

And the Reserve Bank of India’s rate cut proved two things:

First, its new governor, Duvvuri Subbarao, is less afraid of inflation than he is a global slowdown.

“A 100-basis-point cut is an indirect admission that not all is ‘hunky dory’ with the India growth story,” Nandkumar Surti, chief financial officer at JPMorgan Asset Management India Pvt. Bank in Mumbai (JPM), told Bloomberg News.  “One way to look at it is that the global problem has begun to affect us.”

For years, India doggedly raised rates to keep widespread inflation in check. It even went as far as subsidizing food and forcing the state-owned oil companies to sell gasoline to domestic consumers below cost.

And second, Subbarao believes India should taper its economic growth outlook for 2009.

This installment of “Outlook 2009,” report will chart India’s growth next year – its headwinds, tailwinds and possible factors that could turn the direction of either. 

It will also reveal the two best ways investors can ride along with India’s economic growth, and take home profits from India’s bullet-proof industries – and in the process, perhaps even offset some of the losses they’ve incurred here in the U.S. market.

India’s Headwinds  

India’s economy logged an annual growth rate of 7.6% for the quarter ended Sept. 30 – its slowest rate of growth in nearly four years.

India’s farm sector employs about 60% of India’s 1.14 billion people. That was great during last year’s run-up in commodity prices, but those prices have subsequently fallen, and so has the ag sector’s rate of growth – 2.7% in the quarter ended Sept. 30, which is well below the 4.7% pace of a year ago, according to The Wall Street Journal.

Manufacturing – also a powerful economic engine – has also stopped chugging as hard. That sector advanced 5.0% in the last year, a significant drop from the 9.2% growth from the same period the year before.

The global deceleration bears much of the blame for those drop-offs, as the United States far and away, remains India’s top trading partner.

But India is now dealing with a major share of homegrown problems – issues that have become ever more glaring as India’s economy grows in size.

The biggest problem of all: India’s domestic infrastructure is sorely deficient.

The country’s roads and highway systems are a mess, and its power grid is grossly insufficient for an economy of India’s size and rate of growth. That’s an observation that Money Morning guest columnist and well-known India-investment expert Karim Rahemtulla observed firsthand in India last year, when he lead an investor’s field trip around the country. 

And while India has a prosperous and growing middle class, more than 200 million people living there are living in poverty. The government has taken many measures in the past decade to reduce poverty, but Rahemtulla says that the nation’s poor are “mostly against reform because they see little benefit from it.”

In a way, that, too, is an infrastructure issue. India’s poor don’t feel any kind of real connection to the country’s financial system. Indeed, many work day-by-day in the thousands of farming villages. A wave of government reform won’t affect them because they are living at such a far distance – physically, socially and culturally – from the parts of India that would benefit from any changes, new programs, or financial-stimulus efforts.

Even with those obstacles, the World Economic Forum (WEF) and Confederation of Indian Industry predict India will grow 7.4% to 7.8% in the 2008-2009 fiscal year.

But not everyone agrees with that assessment.

“Not going to happen,” Rahemtulla said. “There will be positive growth because India will reduce rates and devalue the rupee in order to stave off economic contraction which it can ill afford.”

But Rahemtulla was just as quick to credit the Reserve Bank of India for taking action as the global financial crisis spread across the world.

“They have explicitly stated they will aggressively promote fiscal and monetary stimulus to promote growth,” Rahemtulla said.

India’s Tailwinds

No question, the global financial crisis has crippled economic growth around the world. But the malaise – combined with the significantly reduced inflation that’s resulted from the downturn – has opened up a straightaway into which India can shift its cautionary policies, refuel its economic engine, and ultimately re-accelerate growth.

“Taking note of the downturn in the inflation rate, RBI has lowered the policy rate as well as the reserve requirements. RBI’s policy is now biased towards stimulating growth,” India’s former finance minister, Palaniappan Chidambaram, said in reference to the steps taken by the Reserve Bank of India.

“If the rate of inflation continues to decline, the policy rates may also moderate and the bias in favor of growth may deepen,” he told economic editors during a meeting late last year, Reuters reported.

India’s annual inflation fell near a 10-year low of 6.38% in December, a dramatic drop from the 13% growth rate in August. The trend is expected to continue, with inflation slowing to 5% or less by March, Pronab Sen, secretary at the ministry of statistics and program implementation, told Reuters. 

That could open a door for the Reserve Bank of India to cut interest rates further, encouraging banks to lend money. And though lower rates may weaken the rupee, Rahemtulla says that will make India’s exports more appealing – especially as countries around the world tighten their belts amid the global financial crisis.

Low inflation isn’t the only tailwind that’ll rebound India’s economy back to its high speed.

India’s overall economy sputtered, but a pair of critical sectors posted promising numbers: Construction is up 9.7% from a year earlier, while India’s service sector has advanced at a robust 10.8% in that same span.

Credit goes to India’s middle class, which, like China’s, is growing in both numbers and overall strength.

Also very promising: Only $1 billion of the Reserve Bank of India’s $510 billion loan portfolio is in toxic Western assets.

That explains why – at a time when the global turmoil has claimed several major U.S. banks – none of India’s banks have gone bust.

India is unmistakably frugal. And its monetary policy proves that it is willing to accept a reputation for being a stifler of growth – instead of being known as being clumsy, overzealous and even reckless, as many U.S. banks are now accused of being.

Two Ways to Play India… for Cheap

Like every major economy, India is falling short of previous economic forecasts in large part because of the global financial crisis.

But make no mistake: Next to China, India’s economy will grow four-to-five times faster than most of the world’s other major economies – many of which are stuck in recession.

For now, investors should target the companies in India that are internationally competitive and are active exporters. That’s because any budget or inflationary difficulties will probably be reflected in a weakening of the rupee, which will help countries exporting from India.

Infosys Technologies Ltd. (ADR: INFY) is India’s premier exporter of software. The company carries almost no debt, and its shares are trading at a current Price/Earnings (P/E) ratio of 12.6, with a dividend yield of 1.48%. That P/E is quite low for a company in a high-growth market such as software.

Dr. Reddy’s Laboratories Ltd. (ADR: RDY) is India’s premier manufacturer of generic pharmaceuticals, and is positioned to benefit in the 2008-2012 period as many popular drugs lose their patent protection and are opened to international competition. In the near term, too, as household and corporate budgets tighten around the world, people will more likely opt for generic prescription drugs, instead of high-price name brands.

Dr. Reddy’s has moderate debt (about 50% of equity), and is trading at 19 times forward earnings – not at all pricey, given the high promise of the generic-drug sector. The stock also features a modest dividend yield of right around 1.0%.

Both stocks are down nearly 50% from their 52-week highs, suggesting value.

[Editor's Note: As the whipsaw trading patterns energy investors have endured this year have shown, the ongoing financial crisis has changed the investment game forever. Uncertainty is now the norm and that new reality alone has created a whole set of new rules that will help determine who profits and who loses. Investors who ignore this "New Reality" will struggle, and will find their financial forays to be frustrating and unrewarding. But investors who embrace this change will not only survive - they will thrive.

Money Morning Investment Director Keith Fitz-Gerald has already isolated these new rules and has unlocked the key to what he refers to as "The Golden Age of Wealth Creation." But Fitz-Gerald brings more than a realization - and an understanding - to the table, here. After a decade of work, he's also developed a new computerized trading model based on a mathematical concept known as "fractals." This system allows him to predict price movements of broad indexes, or individual stocks, with a high degree of certainty. And it's particularly well suited to the kind of market we're all facing right now. Check out our latest report on these new rules, and this new market environment.]

News and Related Story Links:

• Bloomberg:
  India Lowers Key Rate for the First Time Since 2004

• The Wall Street Journal:
  India’s Economic Growth Slows

• Reuters India:
  Gov’t says RBI’s bias towards growth may deepen

• Money Morning:
  Snapshot From India: Advice on Stocks, the Rupee, High Tech and Real Estate

• Money Morning:
  India’s Reliability Provides a Razor Thin Edge Over China

• Money Morning:
  In a Surprise Move, India Lowers Key Interest Rate for the First Time in Four Years

• Reuters India:
  India GDP at 7-7.5 percent in Sept quarter.

• IndiaServer.com:
  Duvvuri Subbarao Is The New RBI Governor.

• Wikipedia:
  Palaniappan Chidambaram.

By Keith Fitz-Gerald
Investment Director
Money Morning/The Money Map Report

In the 20 years I’ve been creating stock-market forecasts, I’ve never seen such a contradictory set of forces at work in the markets all at one time. I could just as easily make the case that we’re finally nearing a bottom, as I could that we’re in for protracted downturn punctuated by sharp, quick drops.
The only question in my mind is what shape an eventual recovery will take, for I see three possibilities:

• A “U,” with a slow, methodical reversal that gradually transitions into a market rebound.
• A “V,” with a quick, sharp reversal that marks the start of a powerful rebound.
• Or a sideways “hockey stick,” in which the downward trend ends sharply – but without the immediate upward surge in stock prices that would constitute a strong rebound.

My proprietary analysis and historical precedents both suggest the “hockey stick” is the most probable scenario. At a time when earnings are slowing and all sorts of red flags are flying, there are still too many unknowns to predict a U-shaped or V-shaped rebound.
Therefore, we believe investors will be best served filling their sails with the winds from the world’s most-powerful trends than they will be by trying to catch the intermittent gales. This is a market that will be dominated by large global trends – and the blue chips that follow them – particularly at a time when the so-called “economic cycle” doesn’t matter much.

Position Yourself to Profit

A properly structured and globally diversified portfolio using the 50-40-10 allocation model (50% “base-builder” foundation investments, 40% global growth and income plays and 10% “rocket rider” speculative investments that will perform well in a recovery) we recommend in The Money Map Report – our affiliated monthly investing newsletter – will prove to be an investor’s best friend. And the reasons for that are as simple as they are compelling:

• First, a properly structured portfolio has built in safety brakes that keep us from making overly risky decisions.
• And second, while this allocation model was constructed to minimize our downside in markets such as the one we’re navigating right now, it also positions us to benefit when the rebound eventually gets under way.

During the past year, we’ve repeatedly urged our readers to make sure two other elements are part of their portfolio: Dividend-paying stocks and specialized “inverse funds” that gain when the markets decline.

While dividends are important in any market, they’re downright crucial now because they add to returns during market rallies and help offset losses during market declines. And our commitment to inverse funds was rewarded during the whipsaw month of October: During a month in which the Standard & Poor’s 500 Index lost 16.8%, the Nasdaq Composite Index shed 16.3% and the Dow Jones Industrial Average dropped 13.9%, all 10 of the best-performing exchange-traded funds (ETFs) were inverse funds, which boasted one-month returns ranging from 36.4% to 66.6%, Thestreet.com reported last week.

Now those are admittedly highly remarkable returns – and clearly aren’t the norm. But it does demonstrate the point we’ve been making: It pays to protect y our downside even as you position yourself for gains. And not only do such investments as inverse funds hedge our downside, they smooth out our overall portfolio volatility and help calm roiled waters.

On a more positive note, we’re now getting to the point where true value is finally being revealed, after years of “irrational exuberance.”
But the reality is – and this is hardly new information for most investors – that global markets in general (and the U.S. stock market in particular) remain fragile, and we expect them to remain that way as long as policymakers continue to interfere with their ability to function freely.

Some readers will no doubt take issue with this, believing that the responses of the U.S. Federal Reserve and other central banks have been necessary. While we respect that opinion, we must also point out that the markets have a remarkable history of sorting out problems on their own – if left to their own devices. However, that’s a largely academic discussion that we’ll leave for another time because the government has already charted a course it believes is prudent.

Even if the world’s central bankers get their act together, the damage has largely been done. What’s more, the various bailout packages – especially the $700 billion U.S. banking bailout – while well intentioned, are almost certain to have more than a few unanticipated consequences.

Topics to Watch

The reality is that these bailout programs remain with us, meaning we must factor them into our efforts to scout out profit opportunities. And on that point, we see five primary areas of change and opportunity:   

• The U.S. Dollar: By pumping an estimated $3 trillion into the global financial system, the U.S. government is setting the stage for the mother of inflationary conflagrations. According to classic economic theory, the greenback should be in an actual freefall right now – especially in the current low-interest-rate environment, where there’s the potential for still more rate cuts and for additional capital outlays by the U.S. government. And that’s just with the current administration. President-elect Barack Obama has made it clear that if an additional stimulus isn’t announced before he takes office, he’ll make that one of his first official acts. What’s saving the dollar, at least for now, is that there’s so much global uncertainty that the dollar is retaining its reputation as a “safe-haven” currency. And, for now, at least, a safe U.S. dollar trumps inflationary concerns. However, should global investors regain confidence for whatever reason, expect the dollar to decline sharply.
• Oil: Many people are focused on declining oil prices as a function of a perceived slowdown in global demand. We think that’s an erroneous analysis for three key reasons. First, oil is still largely priced and traded in U.S. dollars. That means that as the dollar has risen, oil has become correspondingly cheaper. In other words, much of the price decline we’ve seen can simply be attributed to a rise in purchasing power associated with a stronger dollar. Second, China, India and other newly capitalist (and still-reasonably robust) economies are still increasing their oil consumption at a rate that more than offsets the decline in consumption we’re seeing here in the United States and in other developed markets. And third, Brazil aside, there hasn’t been a major new discovery capable of offset global demand on anything more than a temporary basis for more than 30 years, and most major oil fields are in decline or soon will be. Increasing demand and diminishing supply are clearly bullish influences over the longer term. More immediately, however, a stronger dollar negates this and may well keep oil under $100 a barrel for much of 2009. Obviously a terrorist attack would change the ballgame significantly, meaning we could see a spike to levels exceeding our multi-year target price of $225 a barrel. A year ago at this time, we called for oil to spike well up over $100 a barrel, and touch $150, which it essentially did. Even with recent price declines, some energy-industry insiders are starting to subscribe to our bullish outlook: The Paris-based International Energy Agency (IEA) last week projected that long-term oil prices would reach $200 a barrel (although we think that will happen much sooner than the IEA does).
• Commodities: The story is much the same for commodities, in general, and we expect that longer-term investors will be amply rewarded. More immediately, the popular – though erroneous – assumption that a global slowdown will negate demand is driving prices lower, and may continue to do so for the next six months. Gold will be the most obvious casualty in this arena, as hedge-fund-redemption requests and margin calls continue to mount, which is why we expect the price of the yellow metal to remain lower far longer than most people expect (We’ll focus specifically on gold in an upcoming installment of the “Outlook 2009” series). When it does rebound, however, the returns will be high.
• Global Markets: There’s no doubt that the global markets have taken their share of lumps along with their U.S. counterpart in recent months. But we don’t expect them to suffer forever. Countries with high cash reserves as a percentage of gross domestic product (GDP) – such as China, India and Brazil – are becoming less dependent on the fractured U.S. consumer almost daily, and the economic decoupling we’ve seen developing for several years may really take hold in the New Year. This stands in direct contrast to the situation a decade ago, when the Asian Rim and South America were economic train wrecks and the United States and Europe held all the cash. Companies with significant global exposure to the Asian Region, Latin America and Europe – in that order – remain the best bets for relative safety and growth in 2009.
• Stocks in General: Many investors are questioning the wisdom of being in stocks at all. While we certainly understand the pain that sentiment is based upon – and are hurting, too – it’s important to remember that the last time stocks really performed this badly was during the 1930s. Investors who decided to “get out” entirely then missed the investment opportunity of their lifetime. Don’t make the same mistake. Data shows, unequivocally, that investors who buy when the world is going to hell in a hand basket –think 1932, 1942, 1982 and 2003 – enjoy the largest returns. That’s even true if you’re “early,” and buy ahead of the specific market bottom. However, history also demonstrates that investors who pile in at the market’s peaks – such as 1928, 1969, 1999 and 2007 — tend to incur the worst returns.
• Global Stocks in Particular: Led by cash-rich China, we expect global blue chips to remain the best relative bets for safety, income and appreciation potential in the New Year. We are especially focused on companies involved with infrastructure projects and with firms that derive substantial portions of their revenues from Asian consumers. The first is a no-brainer. According to the latest studies from a variety of sources, planned global infrastructure expenditures in this area exceed $40 trillion by 2030. There is not a bigger, more unstoppable trend on the planet today. If you want proof, notice that a big portion of China’s just-announced half-trillion-dollar stimulus package is devoted to infrastructure projects. Infrastructure companies there will certainly benefit. So will consumer-products firms that are positioned to benefit from the rise of an increasingly Asian consumer base, which boasts significant savings and pent-up demand. Many of the best companies are beaten down to the point that they now feature single-digital Price/Earnings (P/E) ratios – lower than we’ve seen in decades. Some are actually trading for less than cash value, despite a strong history of growth. And the companies we’re studying have solid cash flow – and excellent prospects of maintaining it.

Now for the $64,000 question – when could we see a rebound?

We don’t know for sure. Nobody does. History demonstrates that the first and second years of any newly elected U.S. president’s term are almost always problematic. When taken in isolation, we could see a scenario where this is countermanded by President-elect Obama’s planned stimulus, but given the potent combination of flagging earnings and slowing U.S. growth, we’re leery of doing so. [For a story that outlines what an Obama stimulus package could look like, check out this related story on the outlook for the U.S. economy elsewhere in today’s issue of Money Morning.]

On the other hand, for a variety of reasons, history also suggests that if we are to see a rebound, however nascent, the probability is highest for a resurgence starting in the middle of next year. First, since the 1970s, the time between the first and last market lows in any given bear market is an average of seven to eight months. If historical trends hold true, this suggests we could see a bottoming out by the middle of next year. That’s consistent and plausible, especially since other data shows U.S. recessions, on average, last 14.6 months – which also points to a bottoming out in late spring or early summer.

But the biggest indicator of all that we may see a bullish rebound in late spring or early summer – however slight – is admittedly based on emotion. Literally. Small investors have fled the stock markets in droves, and so far they’ve yanked more than $175 billion from the markets, with nearly 50% of that coming out during October alone. Granted, this is a mere 3.2% of the $5.5 trillion invested in stock market funds, according to Forbes, but it’s the first year that net equity flows have been negative since … a drum roll please … 2002.

History shows that small investors may be the most telling of all Contrarian indicators. According to TrimTabs, the Investment Company Institute and our own proprietary research, individual investors have a remarkable habit of rushing in near market tops and fleeing near market bottoms.

That means that long-term investors seeking the best wealth-building opportunities should find the immediate price declines we see ahead to be some of the most compelling buying opportunities of their investing lifetimes.

Now for the caveats – and you knew this was coming – we see three wildcards in 2009, and any one of them could prove to be a joker:

• The continued de-leveraging of hedge funds and other financial institutions.
• More credit-default-swap valuation problems.
• And unknowns associated with the ongoing U.S. and global-economic-system bailouts.

There are still huge questions regarding who owes what to whom, how large the debts are, and exactly who’s going to get what help and when. History shows that the most effective bailouts are those that recapitalize institutions and that allow the weak to fail, which is why we are especially leery of the U.S. government’s plan to acquire bad debt while rewarding weaker institutions that should be put out of their misery.

What’s more, as a Money Morning investigative story demonstrated, many banks are using the government bailout money as takeover capital, and not to boost their lending, which at least would have had an expansionary benefit for the U.S. economy. With most of the bailout programs, and through no fault of their own, U.S. taxpayers and investors have been caught in the middle – or left on the sidelines altogether.

The Outlook 2009 Action Plan

For investors who want to get a head start, it’s important to bear in mind that the markets tend to begin their rebound in earnest anywhere from two months to six months before an actual economic bottom. While that doesn’t suggest going “whole hog” into stocks, it does speak to the need to take some steps now to get ready. Here are the top moves to make now:

• Rebalance Now: As markets have declined, many portfolios have done out of kilter, too – not only in terms of value, but in terms of balance. And that lack of balance can seriously dampen returns, even as we await the market recovery – and even more so once the market begins to rally. It’s far harder to catch a moving train than most investors think.
• Think Safety First: There’s no need to rush into the markets. It’s not clear we’ve hit bottom yet. Keep your powder dry for the better days and easier trades we see developing ahead, while bargain-hunting for those stocks with true upside, and that are positioned to capitalize on the strongest global trends.
• Spread your buys over several days: When you’ve found something to buy, wait for a particularly bad day, then place your order in the last half an hour of trading. Leverage the lower prices (and maximize your returns) by spreading your purchases over several days or weeks. That way you won’t get tripped up by committing your entire nest egg when the market looks cheap and will probably get cheaper.
• Go Global: China is still on track for 9.6% growth this year and may, in fact, slow to a “mere” 8.0% next year. Even that reduced growth rate will probably be about eight times the growth rate of the U.S. economy – if we’re lucky. Consider adding exposure to the Asian Rim as part of the rebalancing process, or as a primary focus once the recovery begins in earnest.
• Get Inverted: Continue to use specialized inverse funds to hedge downside risk. We’re not out of the woods by a long shot.
• Stop Your Losses – with Stop Losses: By all means include trailing stops to control small losses before they become catastrophic ones. This market could easily fall further before it gives way to the rally that history suggests is in the making.

[Editor’s Note: Money Morning Investment Director Keith Fitz-Gerald, a former professional trade advisor, has been following the global financial markets for many years, and is an world recognized expert on China, Japan and other key Asian markets. Last year, Fitz-Gerald headed a two-week investor tour into China, an excursion that put him in touch with insiders in business and government, and enabled him to touch base with many of his longstanding sources in those markets. And share those with readers. Fitz-Gerald is also an expert forecaster, thanks to an uncanny ability to ferret out powerful trends and because of a proprietary system he developed that’s based on “Chaos Theory.” With the U.S. financial markets in such disarray, Fitz-Gerald is using our affiliated monthly newsletter, The Money Map Report to ferret out profit opportunities beyond U.S. borders. In our newest report, we’ve discovered a corporate gem that’s riding the profit wave of the most-powerful global trend we’re following right now. If you act immediately - as an added bonus - you’ll also receive a free copy of CNBC analyst Peter D. Schiff’s New York Times best-seller, "Crash Proof: How to Profit from the Coming Economic Collapse.]

News and Related Story Links:

• Money Morning News:
  Money Morning Investment Director to Lead Two-Week Investor Tour of China.

• Money Morning Investigative Report:
  Billions in Bank Rescue Funds are Fueling Buyout Deals, and not the Increase in Loans That Would Help Ease the Financial Crisis.

• BusinessTimesOnline (UK):
  Energy Agency Forecasts Oil Reaching $200 a Barrel.

• Money Morning Special Investment Report:
  Five Ways to Profit From China’s $585 Billion Stimulus Plan.

• Wikipedia:
  Asian Financial Crisis of 1997 (Asian Contagion).

• Money Morning News Analysis:
  Big Oil Digs Deep to Solve a Growing Problem: Where Will Tomorrow’s Oil Come From?

• Money Morning News Analysis:
  Massive China Stimulus is Viewed as an Attempt to Help the West.

• Wikipedia:
  Bear Market.

• Money Morning Economic Analysis:
  Second, and Possibly Third, Stimulus on the Way as Unemployment Poses Next Major Hurdle for the Economy.

• Money Morning Outlook 2009 Economic Forecast Series (Part I):
  Money Morning Outlook 2009: Obamanomics Offers Investors Plenty of Profit Plays in the New Year.

• Money Morning Outlook 2009 Economic Forecast Series (Part II):
  For the U.S. Economy in the New Year, the Pain Will Precede the Promise.

• Money Morning Credit Crisis Investigative Series (Part I):
  The Real Reason for the Global Financial Crisis…the Story No One’s Talking About.

• Wikipedia:
  Inverse Funds.

• Investorwords.com:
  Economic Cycle.

• TheStreet.com:
  Inverse Funds Surged in October.

By Jason Simpkins
Associate Editor
Money Morning

Oil prices have fallen 70% since hitting a record $147.27 a barrel in July, which means in just five months, crude has given up all the price gains it made in the past four years.

After such a wrenching plunge, many analysts believe the outlook for the “black gold” remains bleak – and in the short term it certainly is. In the long run, however, dwindling supplies, resurgent demand, and a lack of investment will cause crude oil to double, triple, or even quintuple in price over the next few years.

In fact, the Paris-based International Energy Agency (IEA) – energy advisor to 28 industrialized nations – says oil will rise to $100 a barrel by 2015, as a result of a major “supply crunch,” and will ultimately soar to $200 a barrel.

But before it does, prices are likely to sink even further, perhaps falling as low as $20 a barrel in the first quarter of the New Year.

Indeed, much of Wall Street expects oil prices to average about $50 a barrel in 2009. Some of the firms and their specific forecasts include:

• Deutsche Bank AG (DB, which says oil prices will average $47.50 for all of next year.
• Merrill Lynch & Co. Inc. (MER), which predicts that prices will average $50 even.
• Moody’s Investors Service (MCO) also says crude will average $50 a barrel in 2009, but says that average will increase to $55 a barrel for 2010.
• Goldman Sachs Group Inc. (GS) is slightly more bearish, predicting that prices will average $45 for all of next year – after falling as low as $30 in the 2009 first quarter. (It’s worth noting that Goldman – just five months ago – predicted oil prices would hit $200 a barrel in 2009).

But analysts also agree on something else: When the recessionary tide finally recedes, all of the factors that drove oil to its record high last summer will once again be exposed, and crude again will again soar to record highs.

“We may see prices drop lower – into the twenties, even – but there’s a better-than-average chance that they’ll be back over $70 a barrel by the end of next year,” says Money Morning Investment Director Keith Fitz-Gerald. “That’s where firms like Goldman and Merrill are getting all of these ‘middle-of-the road,’ $50-a-barrel estimates. And it’s why investors who buy in through the first quarter could enjoy compelling returns at the end of the year.”

In the meantime, however, low oil prices are crimping investment in new capacity, a reality that will lead to much higher prices down the road.

Just ask the IEA.

IEA: Rising Demand + Lack of Investment = ‘Supply Crunch’

The IEA forecast 2008 global oil demand to slide 0.2%, or 200,000 barrels per day (bpd), to 85.8 million bpd on average. But the IEA also says that oil demand will rise 1.6% a year on average between 2006 and 2030.

The bottom line: Regardless of any short-term pullback, daily demand will rise from the current level of 86 million barrels to 106 million barrels in 2030. To meet that demand, the agency estimates that the world needs $26.3 trillion in supply-side investments over the next 21 years. 

China, India and other developing countries, alone, will need investments of $360 billion a year through 2030, the agency said.

About 7 million bpd of additional capacity needs to be added to the market by 2015. And right now – because of marketplace changes – the financial incentives to make that happen just don’t exist.

Exploration costs have more than quadrupled since 2000, as oil producers have been forced to take on more complex projects, and the costs of both labor and materials have skyrocketed. At the same time, the steep drop in oil prices has put even more pressure on energy companies to curtail their investments rather than increase them.

Earlier this year, for instance, ConocoPhillips (COP) and Saudi Arabia Investment Co. (ARAMCO) were forced to postpone bidding on the construction of a 400,000 bpd export refinery at the Yanbu Industrial City.

“We see and hear about energy investments being delayed … this is a major worry and could lead to a supply crunch and much higher oil prices than we’ve seen before,” said Fatih Birol, the IEA’s chief economist.

The IEA predicts that, by 2015, a lack of investment and rising demand will create a “supply crunch” – that will once again send oil prices up into the triple digits.

“There remains a real risk that under-investment will cause an oil supply crunch in that time frame,” the IEA said in an executive summary of its “2008 World Energy Outlook.” “The gap between what is currently being built and what will be needed to keep pace with demand is set to widen sharply after 2010.”

The agency predicts that crude will average more than $100 a barrel from 2008 to 2015 and rise above $200 a barrel by 2030, as demand far outpaces supply.

“While the situation facing the world is critical, it is vital we keep our eye on the medium to long-term target of a sustainable energy future,” Nobuo Tanaka, the Paris-based agency’s executive director, told reporters in London. “While market imbalances will feed instability, the era of cheap oil is over.”

While it’s probably true that the “era of cheap oil” is in our rearview mirror, a new question has arisen: Just how high do oil prices go?

According to some analysts, the IEA’s target price of $200 a barrel is far too conservative.

$500 Oil?

The lack of exploration and development is certainly a problem. But a much bigger issue is the fact that output from the world’s existing oil fields has sharply declined.

“The future rate of decline in output from producing oilfields as they mature is the single most important determinant of the amount of new capacity that will need to be built globally to meet demand,” the IEA says.

And output from the world’s oilfields is declining faster than previously thought.

In its “2007 World Energy Outlook,” the IEA estimated that output from the world’s existing oilfields was declining by 3.7% a year. But in its latest report, published in November, the IEA revised that estimate to an annual decline of 6.7%. (The November report was based on the first major study of the world’s 800 largest oil fields.)

Unfortunately, the IEA is behind the curve.

For nearly a decade, Matthew R. Simmons has said that the world’s oil production was nearing – or already at – an “inflection point.” While his book “Twilight in the Desert: The Coming Saudi Oil Shock and the World Economy,” was scoffed at when it was originally published back in 2005, Simmons is now viewed as perhaps the preeminent expert on the so-called “peak oil” movement.

“Like most people who ignore conventional wisdom, he was scoffed at, ridiculed, and denied,” commodities guru Jim Rogers told Fortune magazine. “And now, of course, people are starting to say, ‘Oh, well, I thought of that.’”

Simmons, chairman of the Houston-based investment bank Simmons & Co. International, poured through hundreds of technical documents submitted by Saudi oil geologists to the Society of Petroleum Engineers over the past 50 years.

“I finished reading the last paper on a Sunday afternoon,” Simmons told Fortune, “and I sat back and thought, ‘Holy crap, this is unbelievable. I’ve just discovered the biggest energy illusion ever in the world. We’re in big trouble. I’m going to write a book.’ ”

Much of the alleged Saudi Arabia subterfuge has to do with a complete lack of transparency with respect to the Organization of Petroleum Exporting Countries. After OPEC decided to base its production quotas on reserve figures in the 1980s, several of the cartel’s producers suddenly raised their levels of  “proven reserves” by 40% or more.

Back in 1988, for instance, Saudi Arabia raised its proven-reserve figure from 170 billion barrels to about 260 billion barrels. That figure has remained more or less constant since then, despite the fact that billions of barrels of oil have been pumped out of the ground.

“Saudi Arabia has announced for 20 years in a row that they have 260 billion barrels of oil in reserve,” Rogers told Money Morning during an exclusive interview in Singapore recently.  “It’s astonishing.  The figure never goes up and it never goes down.  They have produced dozens of millions – billions – of dollars of oil in that period of time.

“Every oil country in the world has declining reserves except Saudi Arabia,” Rogers said. “And I know that every oil company has declining reserves.  So unless somebody discovers a lot of oil very quickly in very accessible areas, the surprise is going to be how high the price stays, and how high it goes.”

Simmons thinks oil prices could hit $300 a barrel – and could possibly even surge as high as $500 a barrel – during the next several years.

“Black Gold” Profit Plays

When it comes to investing, the oil sector poses some very clear risks, especially given the murky near-term outlook. However, there are a number of large-cap integrated oil companies that may offer some truly compelling values at current prices.

Exxon Mobil Corp. (XOM) and Chevron Corp. (CVX) are currently trading at multi-year lows, making them exceptionally cheap in both relative and absolute terms. These companies also have strong balance sheets (Exxon is “AAA”- rated and has more cash on its balance sheet than debt), generate strong cash flows, and have traditionally increased their dividends on a regular basis.

Chevron was actually recommended as a “Buy” by Money Morning Contributing Editor Horacio Marquez in his “Buy, Sell or Hold” column earlier this year.

“Chevron is the kind of company that is capable of continuing to post large profits – propelling its share higher from current levels – even if oil-and-gas prices were to drop from current levels over the next three years,” Marquez said. “That’s because Chevron’s business is well cushioned, since refining, marketing and chemicals margins would expand dramatically if market ‘spot’ prices were to decline. Also, the company’s production is poised to expand strongly and Chevron uses some selective hedging that works very well in downside oil markets.”

Offshore drillers, particularly those capable of drilling in the deepest waters, also offer value at current levels. Petroleo Brasileiro (PBR), also known as Petrobras, is particularly appealing, as it recently discovered one of the largest offshore oil fields on earth off the coast of Rio de Janeiro. Known as Carioca, the field could hold 33 billion barrels of oil and gas, making the world’s largest discovery in at least 32 years.

Fitz-Gerald, the Money Morning investment director, suggests investors look at China National Offshore Oil Corporation, or CNOOC Ltd. (ADR: CEO). The Hong Kong-based company recently got approval for a $29 billion exploration project in the South China Sea. The company expects to produce 50 million tons of oil equivalent per year from that region during the next 10-20 years. That would equal the production of China’s biggest project, the Daqing Oil Field.

Petrobras and CNOOC are also attractive because, as foreign companies, they will also get a boost from any devaluation in the U.S. dollar.

All of these companies have been hit hard by the combination of commodity-price weakness and credit market turmoil. But these operators do not require peak-cycle commodity prices to generate stellar results and have little or no credit-market exposure.

For a more direct play on oil prices, you might also try an exchange-traded fund (ETF), such as the United States Oil Fund LP (USO), the iPath S&P GSCI Crude Oil Total Return Fund (OIL), or the United States Gasoline Fund LP  (UGA).

[Editor’s Note: As the whipsaw trading patterns energy investors have endured this year have shown, the ongoing financial crisis has changed the investment game forever. Uncertainty is now the norm and that new reality alone has created a whole set of new rules that will help determine who profits and who loses. Investors who ignore this “New Reality” will struggle, and will find their financial forays to be frustrating and unrewarding. But investors who embrace this change will not only survive – they will thrive.

Money Morning Investment Director Keith Fitz-Gerald has already isolated these new rules and has unlocked the key to what he refers to as “The Golden Age of Wealth Creation.” But Fitz-Gerald brings more than a realization – and an understanding – to the table, here. After a decade of work, he’s also developed a new computerized trading model based on a mathematical concept known as “fractals.” This system allows him to predict price movements of broad indexes, or individual stocks, with a high degree of certainty. And it’s particularly well suited to the kind of market we’re all facing right now. Check out our latest report on these new rules, and this new market environment.]

News and Related Story Links:

• Money Morning:
  Crude Oil Futures Post Record Gain as “Peak Oil” Expert Calls for Rally to $500 a Barrel

• Money Morning:
  Cashing in on Commodities: What’s Driving the Oil Bull, How Much Further It Will Go, and How Investors Can Profit

• Fortune:
  Here comes $500 oil

• Financial Post:Delayed energy investment disturbing

• Reuters:Global energy investment hit by financial crisis.

• Wikipedia:
  Peak Oil.

• Money Morning:
  Big Oil Digs Deep to Solve a Growing Problem: Where Will Tomorrow’s Oil Come From?

• Money Morning:Declining Russian Oil Production Could Lead to $200 Oil and “Global Recession,” Says Deutsche Bank.

• Saudi-U.S. Relations.org:
  Yanbu Industrial City.

• Wikipedia:ARAMCO.

• OPEC.org:
  Organization of Petroleum Exporting Countries Web Site.

• Money Morning Exclusive Jim Rogers Interview From Singapore (Part I):
  Jim Rogers: More Pain for the Greenback, and the Failure of the Federal Reserve.

• Money Morning Exclusive Interview From Singapore (Part II):
  Jim Rogers: China’s Economic Advance is All But Unstoppable

If there’s a proverb that captures the outlook for the U.S. economy in the New Year, it’s the one that says: “It’s always darkest before the dawn.”

Regardless of any formal announcement of whether or not the United States drops into an actual recession, the ongoing credit crisis guarantees a contraction of the American economy by virtually every measure we know. That period of darkness will be marked by a dramatic slowdown in economic activity, as well as by rising unemployment, additional declines in U.S. stock prices, and constant volatility. It could last as long as 12-18 months.

But when the dawn does come, it will be one to remember. If U.S. President-elect Barack Obama gets it right – and I have every reason to believe that he will – then investors will be presented with the greatest investment opportunity of our generation. At that point, shares of American companies will be at such low levels that wholesale buying by individuals, mutual funds, pension funds, institutional money managers, and foreign-controlled sovereign wealth funds, will generate gains that will not only make us whole, they will make us rich once again.

A Market Mandela

Creating an analysis of the U.S. economy’s outlook for the New Year is akin to creating a mandala, a geometric work of art whose pattern, symbolically or metaphysically, represents a microcosm of the universe from the human perspective. In some Buddhist temples, mandalas are made of tiny colored beads, painstakingly created by several monks as a form of meditation. In celebration of the ever-changing nature of the universe, the mandala is then joyously shaken by its creators, until it is once again nothing more than chaos embodied in a box of colored beads.

Regardless of the big picture, analysis of a mandala – or the economy – always starts at the center and emanates outward. With the U.S. economy, that centerpiece is credit. The credit crisis has shaken the complex mandala that is our economy and transformed the United States economy into chaos. It’s complex because this economic-forecast mandala derived its form from thousands of individual pieces – in the case of the economy, from scores of data points, many of which are currently dark and foreboding.

The credit crisis we are experiencing results from the contraction – or worse, the cessation – of lending. Under normal circumstances, institutions and markets freely facilitate capital movement between lenders and borrowers. But that’s not happening, now.

Because of a lack of transparency into the balance sheets of borrowers holding such complex and illiquid securities as collateralized debt obligations, credit-default swaps, and non-performing loans, and because of increasing recessionary fears affecting businesses and households, lenders don’t want to increase their loan exposure. Banks are holding onto the cash and liquid securities they control, using them as a cushion against their own potential losses. The U.S. Treasury Department’s direct-to-bank capital injections do not alter these banking realities. In fact, as a Money Morning investigative story recently demonstrated, instead of using these taxpayer-provided infusions to increase their lending, these banks are using the money to finance takeover deals.

The Recipe for a Recession

Whether or not the United States is technically in a recession ultimately will be divined by the National Bureau of Economic Research (NBER). The business-cycle dating committee of this privately run, nonprofit economic research group is right now studying five factors in an attempt to determine if the United States has entered a recession and, if so, when that downturn started, MarketWatch.com reported. Those five factors are:

• Gross Domestic Product (GDP).
• Industrial production.
• Employment
• Income.
• Retail sales.

Regardless of any formal announcement by the NBER of whether we’re in a recession, the credit crisis guarantees a general contraction of economic activity, by every measure.

“Any doubt that we’re officially in a recession can be put aside,” Anthony Karydakis, former chief U.S. economist for JPMorgan Asset Management (JPM) – and now a professor at New York University’s Stern School of Business – recently wrote in Fortune magazine. “The rapid deterioration of labor markets points to a sharp decline in hours worked and output in the fourth quarter. This is likely to lead to a decline in personal consumption to the tune of 5.0% or so for that period. Since [consumer spending] makes up about 70% of the economy, the stage has already been set for real GDP to shrink at a more than 4.0% rate in the fourth quarter.”

Confirmation of that belief is evident by looking at each of the NBER’s five key indicators.

• Gross Domestic Product (GDP): The U.S. Commerce Department estimated that the U.S. economy, as measured by GDP, rose 0.9% in the first quarter. In the second quarter, GDP advanced an estimated 2.8%. For the third quarter, GDP declined an estimated 0.3%. My own econometric models suggest that GDP actually contracted at a 1.5% pace in the third quarter and will decline another 2.75% in the fourth quarter. For the year, that would mean the U.S. economy actually fell 0.55%. The U.S. economy last posted a full year’s negative GDP in 1991, when it declined 0.2%. Verdict: Recession.
• Industrial Production: This measure of output by the nation’s factories and mines dropped 2.8% in September, and a very steep 6.0% in the third quarter. Verdict: Recession.
• Employment: The U.S. Bureau of Labor Statistics announced Friday that October’s unemployment rate was 6.5%, a jump of 0.4%, which was double what most economists expected, and also its highest level in 14 years. The economy has now lost a total of 1.2 million jobs since the beginning of the year, with nearly half of those losses occurring in the last three months alone, pointing to an acceleration in the pace of erosion in labor markets. Karydakis, the Stern School professor, wrote in
  Fortune : “By way of comparison, during the 2001 recession and in the sluggish growth that followed in 2002-03, the unemployment rate reached a peak of only 6.3%, in June 2003. We’ve already exceeded that mark and, given that we are still in the early phase of the current recession, the unemployment rate should be expected to push toward the 7.5% range – and possibly higher – during the next three months to six months.”
  Verdict: Recession.
• Income: Personal income increased $24.5 billion, or 0.2%, and disposable personal income (DPI) increased $25.7 billion, or 0.2%, in September. Personal consumption expenditures (PCE) decreased $33.6 billion, or 0.3%. Excluding the rebate payments made to U.S. taxpayers under the Economic Stimulus Act of 2008, DPI increased $30.3 billion, or 0.3%, in September, and increased $44.0 billion, or 0.4%, in August. Verdict: Too close to call.
• Retail Sales: October retail sales are coming in well below already-diminished expectations, and some reports have been downright depressing – including The Neiman Marcus Group Inc. -26.8%; The Gap Inc. (GPS) -16%; The Nordstrom Group (JWN) -15.7%; J.C. Penny Co. Inc. (JCP) -13%; Kohl’s Corp. (KSS) -9%;  Ltd. Brands Inc. (LTD) -9%; Target Corp. Inc. (TGT) -4.8%; and Wal-Mart Stores Inc. (WMT) +2.4%. In a report last week, Moody’s Investors Service (MCO) projected that the retail sector’s woes will continue into 2009 as consumers cut back on buying apparel, footwear and accessories “in order to save money for essentials.” The credit rating firm said in a separate report that holiday spending “will prove even weaker than expected,” amid October’s financial-market swoon. Verdict: Recession.

If U.S. exports are taken out of the GDP calculations going back to January, it’s apparent that there has been very little domestic growth in the economy. And when revisions are finalized in the next few months, we’ll be looking back at the recession that we’re all but certain is upon us right now. Until the credit markets are freed up and borrowers are extended credit at reasonable rates, it’s unlikely that credit, the centerpiece of the economy, will be anything other than a major cog in the wheel.

There are some signs of a thaw, but not anytime soon. The U.S. Federal Reserve’s lowering of the Fed Funds target rate to 1.0%, and coordinated rate reductions by the Bank of England and the European Central Bank, as well as other major world-wide central banks, may start to ease the stranglehold gripping the worldwide credit markets. The London interbank offered rate (Libor), a critical interest rate against which trillions of dollars of mortgages, bank loans and derivatives are priced, dropped to 2.39% last week from a high of 4.82% on Oct. 10.

The prospect of President-elect Obama’s choosing a different means of attacking the credit crisis will be closely watched and, by itself, may create an air of confidence that perceptions will change. But changed perceptions will not be enough.
The truth about our economic outlook is that it is predicated on demonstrably better transparency. If U.S. banks follow the lead of their European counterparts, which have recently been freed from fair-value, mark-to-market accounting, and which may retroactively mark assets to “internal models” back to July, then balance-sheet clarity will continue to be cloaked in darkness. Lack of confidence in the banking system will persist, especially among the banks themselves. The first order of attack needs to be the creation of a fundamental leadership position that leads to an open, transparent and accountable measure of balance sheet assets and liabilities. As long as failing banks are being propped up, this cycle of credit contraction will persist.

The outlook for the economy is inextricably tied to the price of oil. The run-up of benchmark crude this summer to the record $145 a barrel level, and its subsequent fall to half that level, has wreaked havoc throughout the economy. Similarly, the run-up in commodity prices, and their subsequent fall, also has caused a lot of damage. Together, the dramatic rise and fall in the pricde of oil and other commodities is a harbinger of greater volatility in the future.

Follow the Money

Follow the money. Capital rapidly inflated the tech-stock bubble. When that bubble burst, capital flowed into and flooded the hard-asset world of real estate. When that bubble burst fast, speculative money dove into oil and commodities. When the U.S. and world economies looked weak, those bubbles burst. The looming threat of inflation this past summer instantly gave way after the drop of oil, gold, metals and agricultural commodities. And now, deflation is seen as the looming threat on the horizon.

Which threat should we worry about?

The answer is – both. The prospect for near-term deflation seems all too real. As raw material prices fall and finished good prices fall due to a lack of purchasing power resulting from lack of credit and world-wide recessionary fears, the U.S. consumer has fundamentally changed his or her collective psychology. Is U.S. consumerism, which is responsible for 70% of GDP, in full retreat? If it is, as all measures project, then it’s likely that government stimulus efforts will overshoot their intended mark.
Just look at what the United States has done already as it battles this financial crisis. It has:

• Handed out more than $150 billion in stimulus rebate checks.
• Floated a $700 billion financial bailout rescue plan – almost $160 billion of which has already been placed.
• Bailed out American International Group Inc. (AIG), to the tune of $125 billion.
• Covered JP Morgan Chase & Co.’s bet on taking over
  The Bear Stearns Cos. – to the tune of $29 billion.
• Looked to lend struggling automakers $25 billion.
• Agreed to guarantee depositors at all banks.
• Stepped in to buy commercial paper that no one else will buy.
• Guaranteed money-market-fund investors.
• And backstopped the Federal Deposit Insurance Corp. (FDIC), Fannie Mae (FNM) and Freddie Mac (FRE).

 And now we’re getting wind of another stimulus package and more help for everyone.

If, in six months to a year, the credit markets are facilitating borrowers again, the massive buildup of U.S. debt will result in a falling dollar and higher interest rates.

That spells inflation.

A massive re-inflation of the economy portends another flood of speculative money into oil and commodities. The cycles are increasingly condensed, more volatile and will be increasingly more disruptive.

Welcome to the brave new world of global finance and speculation.

The Federal Reserve’s balance sheet has ballooned from $900 billion to more than $1.8 trillion. That’s 13% of GDP. The Treasury Department has telegraphed its intention to float $550 billion of debt in the fourth quarter and estimates it will have to float another $368 billion in the first quarter of 2009. Our national debt will then be close to 49% of GDP.

If there is an easing of credit in the economy, and borrowers come to market with the pent-up demand that has not been met for the past year, the competition for funds will raise interest rates. Higher interest rates will counter any stimulus effect from government programs.

Who will buy U.S. Treasury debt if the world is less apprehensive about credit quality? Lenders will once again seek higher returns, potentially forcing the Treasury Department to increase its rates. The potential of this event may sink the dollar if investors perceive that the U.S. economy is stagnant and the world is awash in dollars. The yield curve – the spread between the Treasury’s two-year and the 10-year paper – has been steepening. A steepening yield curve, where short-term borrowing costs are low and long-term rates considerably higher, is good for banks that borrow short and lend long.

But if the perception of risk diminishes, and the perception of future inflation increases, the yield curve will invert and the threat of rising rates will cause a sell-off in the short end of the curve and a rush into longer-dated maturities. Any increase in short-term interest rates would be painful for struggling banks. An inverted yield curve would be devastating, and inevitably would lead to more bank failures.

Home on the Range …

At the core of the U.S. economy sits a desperately ailing piece of the mandala – the U.S. housing market. The once bright prospect of home ownership, which historically formed a beautiful economic picture, right now doesn’t exist. For most Americans, the family home constituted the bulk of their wealth. Or at least it did. And this family financial portrait will get worse before it gets better, since the real estate collapse is far from over. Goldman Sachs Group Inc. (GS), for instance, projects another 15% drop in housing prices.

I think that’s conservative. Mortgage rates are actually rising as Fannie and Freddie have to pay higher interest on their short-term notes and bonds. Thirty-year fixed-rate mortgage paper averaged 6.47% last week, up from its 52-week low of 5.36%. The 15-year fixed paper was trading at 6.18%, up from its 52-week low of 4.91% (based on Bankrate.com (RATE) rate surveys). This trend is definitely not our friend. As housing prices continue to fall, and inventories stagnate and grow in many areas, homeowners are increasingly underwater and are increasingly entertaining foreclosure as a viable economic alternative to indentured servitude.
The Hope for Homeowners Plan, which looks to lower interest rates and reduce principal on mortgages, and which makes homeowners pay a share of the appreciation on their home to their lender when they sell it, was initiated in October and was expected to garner some 400,000 takers. As of last week, according to The Wall Street Journal, there had been only 42 takers. That’s not a misprint – 42 – I even checked with The Journal.

In the real estate realm, the proverbial “other shoe” hasn’t dropped yet, but certainly is dangling – and that’s commercial real estate. As homeowners writhe in agony and stop spending, retailers will go out of business, businesses of all stripes will suffer and commercial real estate will implode. The leverage left over from just the private equity foray into commercial real estate in the acquisitive 2006-2007 period is staggering. Refinancing will be impossible. Banks are stuck with hundreds of billions of dollars of leveraged loans that they took on as bridge and mezzanine financing from the private-equity shops alone, at the time believing they would  be able to securitize those loans and sell them off to investors.

There’s no chance of that, now.

One deal in particular illustrates this entire mess.  Private equity behemoth The Blackstone Group LP (BX) took Hilton Hotels Corp. private for $26 billion. Blackstone put up $6 billion of its own money as equity and borrowed the other $20 billion from Bear Stearns, Bank of America Corp. (BAC), Deutsche Bank AG (DB), Goldman Sachs, Morgan Stanley (MS), Merrill Lynch & Co. Inc. (MER) and Lehman Brothers Holdings Inc. (OTC: LEHMQ).

Based on a current analysis of the deal at the multiple of seven times projected cash flow that the market currently puts on Starwood Hotels & Resorts Worldwide Inc. (HOT) -  Hilton’s nearest rival – if Blackstone values its property comparably, it will have to mark its Hilton holdings down 50%, because it paid 13 times projected cash flow. That wipes out all of Blackstone’s equity in the deal. What’s more, the $4 billion portion of the loan that Bear Stearns took on, courtesy of JP Morgan Chase casting off Bear’s orphaned liabilities, now sits on the Fed’s balance sheet – and isn’t likely to go anywhere anytime soon.

Until the real estate cycle completes its implosion and begins to stabilize, there’s nothing that will fundamentally alter the outlook for the economy. This is Ground Zero. President-elect Obama must resist creating only a political solution to the overwhelming economic problem of declining house prices and declining real estate prices in general. Any attempt to put a band aid on this economic plague will only delay the day of reckoning. I regret deeply the conclusion that the lake must be drained before we can realistically climb out of it. But there just aren’t enough ferrymen to get us all to shore.

Always a Silver Lining – My Forecast

The outlook for the economy is not rosy – and that’s an understatement. But there is a silver lining. Even in the near term, the stock market will present innumerable wealth-creation opportunities.

• First, there are plenty of shorting opportunities out there now, and more will present themselves in the future.
• Second, in due course – in perhaps 12-18 months – we will be presented with the investment opportunity of our generation. If President-elect Obama gets it right, and I believe he’s got the potential to bring us all together and get the country through this (and if you’re reading this Mr. President-elect, I’d like to put in my vote for [New York Fed President] Timothy Geithner as next U.S. treasury secretary), American companies will be able to be purchased so cheaply that fortunes will be made. The recovery will not only make us whole, it will make our people and our nation rich again.

I have absolutely no doubt that the United States will lead the world back into balance. The sea change that has arrived is the result of the conservative experiment having lost its true moorings, pushing the economy into disaster. Not that a wholesale swinging of the pendulum to the other side would be good. In fact, it would be disastrous. We have the potential to end up with a new, fair, transparent and judiciously regulated environment where capital formation can again spread its wings and the U.S. economy can fly.

There are new hands reaching into the colorful box of beads that comprise the American landscape and economy. From any human perspective, the United States is more than a microcosm of the universe; it is the center of the world as we know it. It will take time to construct the new mandala. We all need to meditate on the process to ensure that the design we embrace will ultimately be inclusive, forward-looking and – like all great art – an inspiration to all who view it.

[Editor’s Note: Contributing Editor R. Shah Gilani has toiled in the trading pits in Chicago, run trading desks in New York, operated as a broker/dealer and managed everything from hedge funds to currency accounts. In his recent investigation of the U.S. credit crisis, Gilani was able to provide insider insights that no other financial writer or commentator could hope to match. He drew upon the experiences and network of contacts that he developed through the years to provide Money Morning readers with the "real story" of the credit crisis – and to propose an alternate plan of action. It’s a perspective on the near-financial meltdown that more than a quarter-million readers have read in Money Morning alone – to say nothing of the hundreds of other Internet outlets worldwide that have picked up and published Gilani’s unique insights.

How can you protect yourself? Well, with the U.S. financial markets in such disarray, Money Morning is looking for profit opportunities beyond U.S. borders. In our newest report, we’ve discovered a firm that’s been posting quarter-after-quarter of earnings surprises – even as the rest of Wall Street tanked. Not only does this company have a lock on China – the fastest-growing market on the planet – this corporate gem is also riding the profit wave of the most-powerful global trend we’re following right now. If you act immediately - as an added bonus – you’ll also receive a free copy of CNBC analyst Peter D. Schiff’s
New York Times best-seller, "Crash Proof: How to Profit from the Coming Economic Collapse.&quot

News and Related Story Links:

• Money Morning Economic Outlook Series (Part I):
  Money Morning Outlook 2009: Obamanomics Offers Investors Plenty of Profit Plays in the New Year.

• Money Morning Financial Crisis Investigation Story:
  Billions in Bank Rescue Funds are Fueling Buyout Deals, and not the Increase in Loans That Would Help Ease the Financial Crisis.

• Money Morning Credit Crisis Investigative Series:
  Heads They Win, Tails You Lose: Why the Bailout Plan Will Fail U.S. Taxpayers.

• Money Morning Special Investigation of the Credit Crisis (Part I):
  The Real Reason for the Global Financial Crisis…the Story No One’s Talking About.

• Money Morning Special Investigation of the Credit Crisis (Part II):
  The Credit Crisis and the Real Story Behind the Collapse of AIG.

• Money Morning Special Investigation of the U.S. Credit Crisis (Part III):
  How Complex Securities, Wall Street Protectionism and Myopic Regulation Caused a Near-Meltdown of the U.S. Banking System.

• Money Morning Special Report: How to Fix the Credit Crisis (Part IV):
  Dear Hank: Here’s How to End the Credit Crisis at No Cost to Taxpayers.

• Money Morning Special Investigation of the U.S. Credit Crisis (Part V):
  Heads They Win, Tails You Lose: Why the Bailout Plan Will Fail U.S. Taxpayers.

• Money Morning Special Investigation of the U.S. Credit Crisis (Part VI):
  Credit Crisis Update: An Inside Look at the Commercial Paper Debacle.

• Money Morning Special Investigation of the U.S. Credit Crisis (Part VII):
  Inside the Credit Crisis: How the Fed’s Efforts to Lower the Fed Funds Rate May Leave it Powerless to Stop the Financial Meltdown.

• Money Morning Special Investigation of the U.S. Credit Crisis (Part VIII):
  How U.S. Missteps Triggered a Spiral of Worldwide Margin Calls and Deepened the Financial Crisis.

• Money Morning Special Investigation of the U.S. Credit Crisis (Part IV):
  Fears of Mortgage Rate Re-Sets May Fuel LIBOR Manipulation and Mask Deeper Banking System Problems.

• Fortune Magazine:
  Why the jobs report is so ominous.

• International Accounting Standards Board:
  Accounting standards: Commission welcomes IASB guidance on the application of fair value measurement when markets become inactive.

• Investopedia:
  Personal consumption expenditures.

• Money Morning Financial Analysis:
  Bailout Plan Forcing U.S. to Borrow $1.4 Trillion, Creating a $1 Trillion Deficit.

• Wikipedia:
  Economic Stimulus Act of 2008.

• MarketWatch.com:
  Recession arbiter is sifting GDP, jobs data.

• Wikipedia:
  Timothy Geithner.

• Wikipedia:
  Yield Curve.

• Investopedia:
  Inverted Yield Curve.

By Mike Caggeso
Associate Editor
Money Morning

Gold hit two historic milestones in 2008.

First, in early March, the “yellow metal” hit its all-time high of $1,030 an ounce.

Just three months later, the price of gold for December delivery had plummeted to $681 an ounce, a 21-month low and 33.9% drop from its record high.

Most gold bugs were equal parts puzzled and broken-hearted. The world’s stock markets tanked, as did some of its biggest economies. In such an environment, they thought, gold should have risen. After all, gold is widely considered to be a safe-haven investment when everything else is spiraling south. 

However, Money Morning Contributing Editor Martin Hutchinson – an investment banker with more than 25 years’ experience on Wall Street and a leading expert on the international financial markets – understood perfectly what other investors did not.

“Gold is not a safe haven against recession,” said Hutchinson. “It’s a safe haven against inflation.”

In the past year, commodities prices skyrocketed – across the board. That was especially true of oil, which hit a record high $147 a barrel. Corn, wheat, and soybeans all hit record highs, as well.

That price escalation tightened household and corporate budgets, and was a primary reason why the U.S. economy posted a gross-domestic product (GDP) decline of 0.3%. With that negative growth, the third quarter was the beginning of what many experts believe will be the nation’s first recession since 2001.

However, the inflation epidemic has waned significantly, as global demand for raw materials has plummeted.

Price for such staple foods as corn, soybeans and wheat have all come down from their record highs – in near-lockstep fashion.

Corn futures are down nearly 50% from their summer high of $8 per bushel. The same is true of soybeans and wheat, with each having lost roughly half their value. In fact, wheat hit a 16-month low in mid-October.

As most of us noticed, gas prices have fallen 48% from their July 17 high of $4.114 a gallon.

And not coincidentally, gold has fallen 22% in that same time frame.

However, this report examines the pending commodities rebound – a projected slow-and-steady increase in commodity prices that will reverse the breakneck plunge below fair value that commodities have experienced for much of this year.

Our objective now: To chart the expected path of gold prices in the New Year.

This report also reveals another wild card inflationary indicator that Hutchinson believes will carry gold prices to $1,500 an ounce by the end of 2009.

Two Catalysts For Gold’s Climb

The U.S. Department of Agriculture’s Oct. 10 Crop Production Report said acreage for a handful of staple food commodities has shrunk:

• Corn acreage fell 1.2%.
• Soybean acreage dropped 1.4%.
• Canola acreage dropped 1.9%.
• Sunflower acreage shrank 0.8%.
• And acreage of dry edible beans fell 0.7%.

That naturally translates to higher prices because it squeezes the supply of the particular commodity. And it does so at a time when demand continues to escalate from populations in China, India and Latin America. And higher prices equal inflation.

But Hutchinson – who correctly predicted this last run-up in gold prices – says there’s another catalyst that’s right now inherent in the U.S. economy that could help vault gold prices to $1,500 an ounce by the end of 2009. And it has to do with the much-ballyhooed $700 billion rescue plan.

“The government is pumping money in so many banks, and that money has to come out somewhere,” Hutchinson said.

The philosophy behind the rescue plan is elegantly simple: By providing a portion of the $700 billion to foundering U.S banks, the Treasury Department believed it could provide banks with badly needed capital, and get them to start lending money once again – jump-starting the economy in the process.

Since September 2007, U.S. Federal Reserve policymakers have cut the benchmark Federal Funds target rate nine times – from 5.25% down to the current 1.0% rate – to increase bank-to-bank lending and bank-to-consumer lending.

“The government is pumping money in so many banks, and that money has to come out somewhere,” Hutchinson said.

Right now, banks aren’t boosting lending. Instead, they are using the cash to finance buyouts of other banks. Even so, that money will “come out” into the economy in the form of higher stock prices for banks. That will make consumer/investors wealthier, and could make them more confidence in the economy. If they’re more confident, they will spend. As that happens, food prices should begin ticking upward, adding another set of thrusters to gold prices.

“Everybody thinks that because we’re having a horrible recession, we’re not to going have inflation. I think that’s probably wrong,” Hutchinson said. “I think gold has quite good hidden-store value.”

As gold prices increase, count on more investors leaving the sidelines to invest, too, causing the surge in gold prices to accelerate and steepen.

“As gold goes up, it gets more popular and investors start piling into it,” Hutchinson said.  

And if gold gets anywhere near the $1,500 mark, sell. Prices that high will likely fall back or plateau as the Federal Reserve begins raising interest rates and strengthening the U.S. dollar, Hutchinson said.

Five Ways to Play Bottom-Basement Gold

Before we get too far ahead of ourselves, let’s first look at five ways to play bargain-basement gold prices.

The SPDR Gold Trust ETF (GLD) – formerly StreetTracks Gold – is a fund whose shares are intended to parallel the movement of gold prices. Since gold prices started falling along with gas prices, SPDR Gold Trust has stayed within a 0.5% margin of gold prices. This exchange-traded fund (ETF) eliminates any investor concern over storage and delivery while giving them exactly what they want – gold.

Toronto-based Barrick Gold Corp. (ABX) has 27 mines, mostly in North America and South America, and is developing or exploring 11 more. With a market cap of more than $20 billion, it has considerably more liquidity than most mining companies. Barrick is primarily a gold miner, but it also has copper and zinc mining operations. As far as investors are concerned, there are two ways to look at that: It’s not a pure play, per se, but then again, this is a company stock, not a bar of bullion. Also, having operations other than gold can help stabilize the company’s bottom line in case problems arise at a gold mine.

Denver-based Newmont Mining Corp. (NEM) is primarily a gold producer with operations in the United States, Australia, Peru, Indonesia, Canada, New Zealand and Mexico. Its reserves are hovering around 86.5 million ounces. Like Barrick, this is a mining stock play, and is subject to market swings – as well as fluctuations in gold prices. That can be a significant tailwind, especially if you believe the stock market has bottomed out or is close to doing so. Hutchinson – forever a value-oriented investor – warned that Newmont might be a little too pricey now. Investors may want to wait for the company’s stock price to settle before getting in.

Hutchinson thinks the best value for a gold mining stock can be found in Yamana Gold Inc. (AUY), another Toronto-based company that’s small now, but has rapidly expanding production. 

But for investors who just want gold – not an ETF or stock – the best avenue is an EverBank Select Metals Account: EverBank accounts has a minimum deposit that is 98% lower than its competitors, and its commission costs are up to 86% lower than other metals’ brokers and bullion banks. It offers two types of gold accounts: Unallocated (your purchased gold is pooled with that of other investors, eliminating storage and maintenance costs; the minimum deposit is $5,000), and Allocated (you directly own the gold you purchase, held in your own private account; $7,500 is the minimum deposit here).

Both types of accounts can be set up 24/7 online. But if you prefer the phone, call 866-326-6241, and be sure to give them the code 12608 when setting up an account.

We should point out that the publisher of Money Morning has a marketing relationship with EverBank, but that’s because its products are among the best in class.

[Editor’s Note: Money Morning continues to track the global financial crisis, chronicling the key news stories emanating from the global financial crisis. With the U.S. financial markets in such disarray, we’re using our affiliated monthly newsletter, The Money Map Report, to spotlight the very best profit opportunities we’re discovering in markets throughout the world. In our newest report, we’ve discovered a corporate gem that’s riding the profit wave of the most-powerful global trend we’re following right now. If you act immediately - as an added bonus - you’ll also receive a free copy of CNBC analyst Peter D. Schiff’s New York Times best seller, "Crash Proof: How to Profit from the Coming Economic Collapse.]

News and Related Story Links:

• Money Morning 2009 Economic Outlook Series (Part I):
  Money Morning Outlook 2009: Obamanomics Offers Investors Plenty of Profit Plays in the New Year.

• Money Morning 2009 Economic Outlook Series (Part II):
  For the U.S. Economy in the New Year, the Pain Will Precede the Promise.

• Money Morning 2009 Economic Outlook Series (Part III):
  Unprecedented Volatility Will Continue to Rock the Stock Market in Advance of a Possible Rebound in Mid-2009.

• Money Morning 20090 Economic Outlook Series (Part IV):
  
  If Japan Bounces Back in the New Year, Investors Will, Too.

• Associated Press:
  Gold briefly drops to 21-month low as stocks fall

• MarketWatch:
  Food/Fuel Reality Check: "Speculative Bubble" Was Real Source of Corn Price Increases Says New Study

• Truth About Trade & Technology:
  Glory Days Fade for U.S. Farmers

• USA Today:
  Big Drops in Prices for Crops Make Tough Down on the Farm

• CNNMoney.com:
  Oil settles above $67

• USDA:
  USDA Corrects October Crop Acreage Estimates

By Jennifer Yousfi
Contributing Writer
Money Morning

Retail experts are predicting one of the most dismal holiday shopping seasons in decades this year – a crucial stretch that will set the stage for poor retail sales throughout 2009.

As the U.S. economy decelerates, pummeled by the aftershocks of the worldwide financial crisis, consumers have been hit from every direction: Unemployment has spiked, and will continue to rise, economy unwinds and continues to work through the aftershocks of the global credit crisis, consumers have been beset on all sides. Unemployment is up, home prices are down, and credit is hard to come by.

And although inflation is beginning to moderate somewhat – slowing to a pace of 3.7% year-over-year in October – it’s still well above the U.S. Federal Reserve’s desired target rate of 2.0%.

With rampant inflation no longer artificially propping up consumer spending figures, retail sales have really started to lose their luster. Sales figures are based on the value of goods sold – not the volume – so the recent decline commodity and energy prices will translate into a sharp decline in retail sales.

That decline will be dreadfully apparent in this year’s holiday sales, but it will also carry into 2009. The question, now, is how much worse consumer behavior will get.

"The great unknown is just how much lower can consumer spending go?" Piper Jaffray Cos. (PJC) analyst Jeff Klinefelter told Reuters. "With savings rates at historic lows and constraints on the availability of consumer credit, I just think there’s concern that the perfect storm is brewing."

According to the Fed, a recession is already under way in the United States. Gross domestic product (GDP) shrank 0.5% in the third quarter, and the Fed predicts the economy will continue to contract in the first six months of 2009, and possibly beyond.

Tighter credit standards and lower home prices mean consumers have less of an ability to finance their purchases through debt. And even those with cash to spend are opting to save instead, as the economic outlook continues to dim. Would-be consumers are also scrambling to rebuild savings that were decimated by a bear market that has dragged the Standard & Poor’s 500 Index down more than 40% this year.

"We expect to see consumer spending to be flat before inflation," Gus Faucher, chief U.S. economist with Moody’s Economy.com (MCO), told the Los Angles Times. That means once inflation is factored in, consumer spending will see a sharp decline in 2009, and retail sales will be left to twist in the wind.

Retail Laggards

According to a recent retail outlook report from Fitch Ratings Inc., personal consumption expenditures are projected to decline 1.6% in 2009.

A wave of consolidation and bankruptcies will spread through the retail sector as weaker chains fail and stronger brands shut down underperforming stores. Department stores and specialty stores will be hit especially hard, as consumers cut back on discretionary purchases in favor of staples.

Bankruptcies of stores such as Sharper Image Corp. (OTC: SHRPQ) and Circuit City Stores Inc. (OTC: CCTYQ) are having a negative effect on the sale of gift cards, which stores traditionally have counted on to boost sales after the holiday season. Gift card purchases are tallied when the card is redeemed, not when the card is purchased. In the past, the sale of gift cards have given New Year sales a healthy boost as gift card recipients go shopping after the holidays are over. 

But consumers are wary of getting left holding onto worthless cards while bankruptcy courts decide how to divvy up assets.

For the 2007 holiday season, 70% of consumers purchased gift cards. This holiday season, just 40% of consumers are projected to go the gift card route. And that’s going to weigh down sales and profits for the 2009 first quarter.

"I think you will see a six-point drop in sales for those first three months," C. Britt Beemer, chief executive officer of America’s Research Group and author of “The Customer Rules,” told CRM Magazine.

Troubles Beyond the Big Brick-and Mortar Stores

While the big chains are struggling and grabbing the bulk of the headlines, small business owners are barely getting by. That might not seem like a big deal if the stock market is your focus, but small-businesses are integral to the economy.

According to the Small Business Administration, businesses with less than 500 employees account for almost half of private-sector employment. A recent National Federation of Independent Business survey showed 15% of small business owners anticipate layoffs in 2009, which will put even more strain on an already weak U.S. labor market.

And small business layoffs mean slower sales for big box stores like Best Buy Co. Inc. (BBY) and Target Corp. (TGT) as another wave of unemployed workers grapple with lost income.

Online retailers are starting to feel the pinch, too. Web sales have been one of the fastest growing retail sectors for years, but popular sites such as Zappos.com Inc., the No. 1 online shoe retailer, and QVC Inc., which sells online and on television, have each announced layoffs, as well as declining sales.

Amazon.com Inc. (AMZN), the top online retailer, also is struggling. Amazon’s stock is down 55% year-to-date, and the outlook is grim.

“[Amazon is] seeing a slowdown in their business that shouldn’t really shock anybody,” Jeffrey Matthews, a general partner at hedge fund Ram Partners LP in Greenwich, Conn., told Bloomberg. “They sell books. They sell movies. They sell blenders. They don’t sell magic potions or the fountain of youth.”

Retail’s Bright Spots

There are a few retailers that – while they don’t sell magic potions or the fountain of youth – have managed to position themselves as offering more value for the money, which has allowed them to buck this downward spiral in consumer spending have managed to buck dismal consumer spending. And that focus on value will continue in 2009.

The best example of this value exception is the world’s largest retailer: Wal-Mart Stores Inc. (WMT).

"This is Wal-Mart time," Chief Executive Officer H. Lee Scott Jr. told Wall Street analysts during an Oct. 27 presentation at company headquarters in Bentonville, Ark., BusinessWeek reported. "This is the kind of environment that Sam Walton built this company for."

The economic slump has found Wal-Mart returning to the basic strategies that the late founder made famous. The retail titan has given up on the brand-name designer strategy of competitors such as Target and Kohl’s Corp. (KSS) to offer rock-bottom prices on hundreds of consumer staples.

That bodes well, as consumers will continue to stretch household budgets and consolidate trips to save on gas.

“It is a great time to be Wal-Mart,” Howard Davidowitz, chairman of Davidowitz & Associates, told Bloomberg News. “It sells everything you need cheap.”

Stores like Wal-Mart, that can capitalize on this new value-seeking behavior will be able to turn a profit even in this bleak retail environment. And those that can’t, will be bought out or disappear.

News and Related Story Links:

• MarketWatch:
  Fitch U.S. Retail Outlook: Navigating a Difficult Path for Holiday and 2009

• Los Angeles Times:
  Federal Reserve sees recession to at least mid-2009

• Reuters:
  Retail sales worst in decades; holiday view cut

• Bloomberg News:
  Wal-Mart ‘Optimistic’ About Holiday Shopping Season

• BusinessWeek:
  For Exiting Wal-Mart CEO, a Victory Lap

• The Wall Street Journal:
  Consumer-Spending Report Is a Glimpse of Pain to Come

• destinationCRM.com:
  009 Holiday Retail Forecast: "It’s Going To Be a Disaster."

• CNNMoney.com:
  Here for the holidays: Slow sales and layoffs

• Bloomberg News:
  Amazon.com Lowers Forecast as Wall Street Crisis Hits Web Sales.

• Time 100:
  Sam Walton.

By Don Miller
Contributing Writer
Money Morning

The U.S. housing market is already being pounded by the “perfect storm.” And the outlook for the New Year is for the stormy weather to continue – and probably to get worse.

As if a locked-up credit market and tidal waves of foreclosures weren’t already enough, we’re now watching unemployment climb and consumer confidence plunge.

But even when the housing market is taking on water, there are ways to stay afloat. Indeed, investors nimble enough to maneuver can even make money.

The watchword on this market, though, is caution.  If an investor decides to test the waters, beware of the extraordinary financial undertow.

Here’s a look at what’s happening now, and what the implications there are for investors in the New Year.

Rising Unemployment Feeds into Sinking Demand

The grim reality is that skyrocketing unemployment is a major threat to the recovery of the U.S. housing market.  And consumers shackled with record levels of debt are unlikely to ride to the rescue this time.

Since this recession is expected to be long and deep, economists are projecting high rates of unemployment. And the latest statistics released by the U.S. Labor Department show the crucial jobs market deteriorating at an alarmingly rapid pace.

The U.S. unemployment rate jumped to a 14-year high of 6.5% in October as another 240,000 jobs were cut – an uptick from 6.1% in September and the 10th month in a row the jobless rate has risen. Most forecasts are calling for unemployment to spike as high as 8.5%, which would be the worst showing since 1980.

So far this year, a staggering 1.2 million jobs have disappeared. More than half the decrease occurred in the past three months alone, Money Morning reported in its “Outlook 2009” series economic forecast story. Even worse: A year ago, job cuts were concentrated in the financial-services and homebuilding sectors. Now they’re rising across the board; virtually every part of the economy is feeling the squeeze.

For instance:

• U.S. automaker Chrysler Corp., one of Detroit’s wheezing “Big Three,” is laying off 25% of its white-collar work force of 18,500.
• Appliance maker Whirlpool Corp. (WHR) recently announced it would cut 5,000 jobs to cope with declining sales.
• Worldwide shipping giant DHL, a subsidiary of Deutsche Post AG, is laying off 9,500 people, and threatening to close its U.S. distribution center.
• Onetime Internet search giant Yahoo! Inc. (YHOO) plans to let 1,100 workers go – on top of the 1,000 already jettisoned in January – the result of several botched merger attempts.
• Ailing banking giant Citigroup Inc. (C) heaped more bad news on the financial sector, announcing whopping 50,000 layoffs in the next 12 months.

Layoffs of this magnitude are more than a mere shot across the bow of the housing market – they’re actually a direct hit amid ship. People who are unemployed cannot buy homes. Period. But even consumers who are afraid that they might be joining the jobless ranks are loath to take on the added risk – making them unlikely candidates to buy a new home.

Foreclosures Still Rising

As unemployment climbs, foreclosures will continue to multiply. That only exacerbates an already unappealing combination – more houses being dumped onto the market even as the pool of potential buyers grows increasingly smaller.

RealtyTrac Inc. reported that more than 81,000 homes were foreclosed on in September – 71% increase from the same period just a year ago. For 2008, foreclosures rose to a record 765,558.

“I wouldn’t be surprised to see foreclosures increase as the economy slows down,” said Rick Sharga, RealtyTrac’s vice president of marketing. “The people living paycheck to paycheck are at risk if they lose their jobs. It will cause more people to lose their homes.”

And while foreclosure volumes are outpacing projections, the cumulative losses by banks on bad mortgages may have yet to hit their books.  Since loan losses don’t get recorded until the property is sold, it’s likely there’s a lot of bank-owned inventory that hasn’t been unloaded – meaning there may be more foreclosures out there investors don’t yet know about.

“We are in uncharted waters,” said Brian Bethune, an economist at research firm Global Insight (IHS).

Making the waters even rougher was the decision by Standard & Poor’s Inc. (MHP) to cut the ratings on $34.1 billion of “Alt-A” residential loan packages that had been issued in 2006 and 2007.  Alt-A mortgages are those written with little or no documentation, i.e., without proof of income or assets. Even worse, S&P put an additional $351.7 billion of Alt-A securities up for possible review reflecting the rating company’s “belief that further declines in home sales will depress prices further and push loss severities higher than we had previously assumed.”

On top of all that, record numbers of borrowers are already “underwater,” or “upside down” on their mortgages, making it more attractive for them to default by simply walking away, than to hang around and drown.

About 18% of homes nationwide are now “upside down,” according to a report from First American CoreLogic.  Almost two-thirds of those homes are in just seven states: Arizona, California, Florida, Georgia, Michigan, Nevada and Ohio. In Mountain House, Calif., an unincorporated planned housing community located in the foothills of the Diablo mountain range, the housing crisis right now has nearly 90% of the homeowners owing more on their houses than they are worth – the highest percentage in the country, The New York Times reported on Nov. 10. The average homeowner is underwater by $122,000, the newspaper said.

Other areas are suffering almost as much: In Nevada, alone, borrowers owed a whopping 89% of the value of their homes.

Despite such dramatic anecdotes, this housing slump is nationwide in nature. It’s more severe than any other such downturn since World War II, mostly because of the risky lending practices that inflated the real-estate bubble in the first place.

The Downdraft in Housing Prices 

Meanwhile, while unemployment rises, the downward spiral in housing prices is gaining momentum.

“The No.1 thing that drives housing values is incomes,” said Todd Sinai, an associate professor of real estate at the Wharton School at the University of Pennsylvania. “When incomes fall, demand for housing falls.”

The S&P/Case-Shiller Index of home prices plunged 16.6% in August from the year before, following a 16.3% drop in July. The index has fallen every month since January 2007 (See accompanying chart, “Plummeting Prices.”).

Prices were lower in all 20 of the major cities the index covers, with Phoenix and Las Vegas down nearly 31% from last year.

Nationwide home prices have fallen 20.3% since peaking in June 2006.

And the skid isn’t over.

According to Fitch Ratings Inc., U.S. home prices will fall another 8% to 10% before they show signs of stabilizing.  According to a Fitch forecast, the peak-to-trough price decline will be 30%.

And still one other reliable indicator of housing prices seems to confirm that, in many cities, home prices still have further to fall.

According to analysis by Moody’s Investors Service (MCO), Miami houses are right now priced at about 22 times annual rental income – versus an average of just 15 over the past two decades. This suggests that a home currently priced at $350,000 is actually worth only $238,600 – meaning the price would have to drop 32% to reach the fair-value point.

Congressional Missteps

In an effort to help more than 400,000 homeowners avoid foreclosure, Congress came up with the “Hope for Homeowners” program.  Unfortunately, in their infinite wisdom, federal lawmakers designed a program that is almost certain to fail.

The program supposedly makes as much as $300 billion available to at-risk borrowers, enabling them to refinance into a 30-year, fixed-rate loan insured by the Federal Housing Administration (FHA).

The biggest mistake Congress made was to make this program strictly voluntary for participating banks, experts say.

Just as bad: In an effort to make the program more affordable for beleaguered homeowners, it also requires the lenders to write the value of the home down to 90% of its current market value. So in a downtrodden market like Phoenix, if a lender holds a $400,000 mortgage on a home currently appraised at $300,000, the bank would have to settle for a new mortgage worth only $270,000. 

Needless to say, the response has been underwhelming.  After four weeks, a whopping 79 people had applied for the program.

Not to be deterred, the Federal Deposit Insurance Corp. (FDIC) is proposing another package, which would extend the terms of at-risk loans from 30 years to 40 years, with interest rates as low as 3.0%.  Housing payments for delinquent borrowers could not exceed 38% of gross monthly income.

In order to sweeten the pot for lenders, the government would share as much as 50% of the losses if a borrower ended up in default anyway.  In addition, the FDIC would pay servicers who process these new mortgages a fee of $1,000 for each re-worked loan.

FDIC officials estimate that this anti-foreclosure program would cost $24.4 billion, and would prevent 1.5 million of the 2.2 million at-risk homes from falling into foreclosure. 

But that also means the taxpayer will be on the hook for half the value of 700,000 mortgages that do fail.

Can you say “fuzzy math?”

Homebuilders on the Ropes

You can probably guess where this leaves the nation’s homebuilders – gasping for air.

D.R. Horton Inc. (DHI), one of the nation’s biggest homebuilders, just wrote down $1.1 billion in land, deposits and inventory in the third quarter, as sales fell by half. The Ft. Worth, Tex.-based company expects to post a fourth-quarter net loss of between $800 million and $900 million, 18 times more than it lost in the fourth quarter a year ago.

Other builders are in similar shape. Pulte Homes Inc. (PHM) and The Ryland Group Inc. (RYL) just reported quarterly losses of $280.4 million and $65.7 million, respectively. 

Even Toll Bros. Inc. (TOL), which caters to the high-end buyer, said fourth-quarter revenue fell 41% from the same period last year.

The Forecast for 2009: More Pain Before Any Gain

No matter what happens in the U.S. housing market, until a large inventory reduction takes place, housing prices will not stabilize.

In a recent Forbes magazine column, A. Gary Shilling, president of an economic consulting firm of the same name, said the worst is yet to come. Says Schilling: “Excess inventory, the mortal enemy of prices, now amounts to 1.8 million homes, which is a huge number relative to the net demand (new families minus departures due to deaths and moves to nursing homes) which is only 1.5 million a year.”

And one of the architects of the U.S. housing debacle – former U.S. Federal Reserve Chairman Alan Greenspan – is also downbeat: “At a minimum, stabilization of home prices is still many months in the future,” Greenspan said in an October speech.

The question that needs to be answered, then, is this: In the current atmosphere, does anyone believe we actually need homebuilders to add even one new home to the market?

Some pundits claim this may be a golden opportunity to short U.S. homebuilders. Even though they’re already down 80% from their highs, the deadly combination of skyrocketing unemployment, deflating prices and tight credit continue to spell further pain for the industry.

Short sellers would obviously look at any of the companies mentioned above. They might also consider iShares US Home Construction (ITB), the prominent exchange traded fund (ETF) for the group. However, any such move would have to be made with extreme caution.

The reason: All bets are off if the new Barack Obama Administration implements a moratorium on mortgage foreclosures. There’s also the possibility that Obama will be able to shepherd through any one or more of the proposed mortgage guarantee programs now on the table. 

Those kinds of moves could provide a boost to homebuilders and leave short sellers in the grips of an uncomfortable squeeze – just like the millions of homeowners saddled with mortgages they can no longer pay.

[Editor’s Note: With our ongoing “Outlook 2009” economic forecasting series, as well as our newly launched “Profiting From the Aftershocks” series, MoneyMorning continues its unrivaled coverage of the global financial crisis – chronicling the key news stories, while also uncovering cutting-edge profit plays. Our two newest special-investment research reports highlight these efforts. In the first, we detail the five financial-crisis aftershocks we believe will create the greatest profit opportunities of this generation. In the second report, we show you how to “crash-proof” your investments – and we detail a corporate gem that’s riding the profit wave of the most-powerful global trend we’re following right now. In the “Outlook 2009” series, we last wrote about the prospect for gold prices in the New Year. Next up in the “Outlook” series: Latin America and U.S. retail sales.]

News and Related Story Links:

• Yahoo! Finance/The Associated Press:
  Jobless rate bolts to 14-year high of 6.5 percent.

• Money Morning Outlook 2009 Series (Part II):
  For the U.S. Economy in the New Year, the Pain Will Precede the Promise.

• Wikipedia:
  U.S. Housing Bubble.

• Money Morning News Analysis:
  
  Yahoo! Searching for Answers After Google Walks Away from Ad Deal.

• Money Morning News:
  Citigroup Whacks Another 50,000 Jobs; Cuts Expenses by 20%.

• Wikipedia:
  
  Alt-A Loan Packages.

• The New York Times:
  
  A Town Drowns in Debt as Home Values Plunge.

• WiseGeek.com:
  What is an Underwater Mortgage?

• Money Morning News Analysis:
  
  Government Rolls Out Long-Sought-After Anti-Foreclosure Program.

• PressRelease.com:
  
  D.R. Horton, Inc., America’s Builder, Reports Preliminary Fiscal 2008 Fourth Quarter Results.

• Forbes.com:
  We Haven’t Seen the Worst, Yet.

• ContrarianProfits.com:
  Now Is a Good Time to Short the Homebuilders ETF (XHB).

By Martin Hutchinson
Contributing Editor
Money Morning/The Money Map Report

Japan has been an infuriating country for U.S. investors for almost 20 years now, since its benchmark Nikkei 225 index hit its trading high of 38,957 in late December 1989. The market then dropped steadily to a third of its peak value by the end of 1998, zoomed back up to 20,000 in March 2000, fell to a low of 7,600 in March 2003, and then recovered to 17,600 in June 2007.

Now, however, it has swooned to 8,695, infuriating global investors. And there’s two ways to look at it.

You can regard it as hopeless case, a market stuck in permanent recession.

Or you can look at the money investors made in 1998-2000 and 2003-2007 and say: “It’s down close to 8,000 again, lads. Time to pile in!”

On the whole, I’m inclined to the second view.

Burst Bubbles

Japan made a number of mistakes in the 1990s – most notably in allowing its public sector to grow so much that it delayed the recovery from the inevitable downturn brought on by the huge Japanese stock market and real state bubbles of 1985-1990.

However, the Japanese economy’s productivity hasn’t stopped growing: According to The Conference Board Total Economy Database, the world’s second-largest economy grew at an average annual rate of 2.0% from 1990 to 2007, outstripping the U.S. productivity growth rate of 1.8%, and the 1.6% rate of Germany, for instance. Thus, Japan’s economy retains considerable dynamism, and being almost two decades from its bubble excesses, has worked the bad debts and overvaluations out of its system.

One factor that tends in the opposite direction is the September ascent to power of new Japanese Prime Minister Taro Aso.

Back in 2003, before Aso came to power, then-Prime Minister Junichiro Koizumi had finally (it seemed) quelled the public spending barons in Japan’s Liberal Democratic Party and cut back infrastructure investment. Koizumi’s two successors were both similarly committed to spending restraint – highly necessary in a country whose debt had peaked at 180% of gross domestic product (GDP). However, Prime Minister Aso also is a believer in “stimulus,” and with so many bad examples internationally (and others – such as China’s – so new that we can’t yet pass judgment on them), it seems inevitable that he will relax Japan’s budget discipline. This may help the country’s slowing economy in the short run, but in the long run it threatens to return Japan to its stagnant state of the late 1990s.

Nevertheless, Aso’s first stimulus program – announced Oct. 31 – was a fairly modest $30 billion (about 27 trillion yen), or roughly 6.0% of GDP. What’s more, only $5.56 billion (about 5 trillion yen) of that outlay represents actual new spending, with the rest represented by tax rebates and service-charge reductions. So, while Japan’s deficit and debt will increase, the government’s share of the economy won’t increase much. This brings hope that Aso will remain sufficiently restrained in new public spending programs to allow the Japanese economy to start growing again.

The financial markets seem to think the outlook for renewed growth is quite good; the yen has been very strong in the last few months, reaching a level of Yen 92 = $1 that it had only touched in the middle 1990s (Yesterday, Yen 95.95 = $1 USD).

Of course, it doesn’t hurt that Japanese banks – restrained from rapid expansion in the 2003 to 2007 time frame because of their previous bad debt problems – had been lucky enough to avoid most of the U.S. subprime mortgage mess. This is all bodes well for carefully chosen Japanese stocks.

Reaping Profits

With faster productivity growth than the United States, a reasonably valued stock market, and some degree of shelter from the storms afflicting the rest of the world, Japan is an essential home for a portion of your international investments. While Tokyo will most definitely be affected by a continued decline in the worldwide stock markets, if viewed solely on its own merits, the Japanese stock market seems more likely to rise than fall. You never know: We could be close to the beginning of a long, secular bull market – it has been a full generation since the last one. More likely, the market will just bounce a bit. Still, even bounces are worth buying.

In terms of which Japanese shares to buy, the major electronics and consumer goods exporters should be avoided – their earnings have been decimated in the past few months. One exception to this is in the auto sector: Honda Motor Co. Ltd. (ADR: HMC) has a better model range and is better aligned for a world marketplace plagued by expensive fuel and environmental pressures than any other manufacturer on the planet. But it too has been knocked back by the problems of auto manufacturers in general.

Honda’s American Depository Receipts (ADRs) are down about 36% from their 12-month highs. But at about 9.0 times estimated earnings to March, with a dividend yield of 3.6%, they seem a good value.

The profit problems of the major Japanese high-tech companies have caused the entire tech sector to suffer earnings reverses – except the domestically oriented cellphone company NTT DoCoMo Inc. (ADR: DCM). Naturally, DCM’s sales and earnings have been growing only slowly in Japan, because the wireless-communications market is saturated. But the company addressed this problem on Nov. 12 by shelling out $2.7 billion for 26% of the Indian cellphone company Tata Teleservices Ltd., entering into a technical cooperation agreement.

As of Sept. 30, India had 315.3 million cellphone subscribers, up 51% in the year and surpassing the overall U.S. population for the first time. With a forward Price/Earnings (P/E) ratio of 13 (based on earnings to March), and a dividend yield of 3.0%, DCM is also a bargain – given the technological improvements in the sector and its new growth potential in India.

Finally, a “fundamental” product – and one that’s primarily domestically oriented – is the chief business of Wacoal Holdings Corp. (ADR: WACLY), the world’s largest manufacturer of intimate apparel. Wacoal dominates the Japanese market, which accounts for 85% of its sales. Any economic recovery in Japan is likely to be domestically based, thanks to sluggish export growth and the strong yen. Hence, Wacoal is well positioned to benefit. The stock is trading at about 20 times forward earnings to March, and has a dividend yield of 2.2% – pricier than the other two, but worth a modest investment.

[Editor’s Note: When it comes to the international financial markets, Money Morning Contributing Editor Martin Hutchinson brings readers a unique brand of expertise. In February 2000, for instance, when he was working as an advisor to the Republic of Macedonia, Hutchinson figured out how to restore the life savings of 800,000 Macedonians who had been stripped of nearly $1 billion by the breakup of Yugoslavia and the Kosovo War.  Hutchinson warned Money Morning readers about the dangers of credit-default swaps back in April – long before the collapse of American International Group Inc. (AIG) made them a household word – and his recent analysis of how the U.S. stock market would respond to the credit crisis proved to be incredibly accurate. Hutchinson is also a regular contributor to our affiliated monthly investment newsletter, The Money Map Report, in which we work to ferret out profit plays – no matter w here they are in the world. In our newest report, we’ve discovered a corporate gem that’s riding the profit wave of the most-powerful global trend we’re following right now. If you act immediately – as an added bonus – you will also receive a free copy of CNBC analyst Peter D. Schiff’s New York Times bestseller, "Crash Proof: How to Profit from the Coming Economic Collapse.]

News and Related Story Links:

• Money Morning Market Commentary:
  When Gridlock is Good: Why a Contentious Election and Legislative Bottlenecks Pack a Profit Punch for Investors.

• Money Morning 2009 Economic Outlook Series (Part I):
  Money Morning Outlook 2009: Obamanomics Offers Investors Plenty of Profit Plays in the New Year.

• Money Morning 2009 Economic Outlook Series (Part II):
  For the U.S. Economy in the New Year, the Pain Will Precede the Promise.

• Money Morning 2009 Economic Outlook Series (Part III):
  Unprecedented Volatility Will Continue to Rock the Stock Market in Advance of a Possible Rebound in Mid-2009.

• Money Morning Special Investment Report:
  Five Ways to Profit From China’s $585 Billion Stimulus Plan.

• Wikipedia:
  Japanese Asset Price Bubble.

• Wikipedia:
  Japanese Prime Minister Taro Asio.

• Money Morning News Analysis:
  Massive China Stimulus is Viewed as an Attempt to Help the West.

• Wikipedia:
  List of Countries by Nominal GDP.

• Money Morning Market Analysis:
  Credit Default Swaps: A $50 Trillion Problem.

By Martin Hutchinson
Contributing Editor
Money Morning/The Money Map Report

With his landslide election victory Tuesday – coupled with Democratic gains in the House of Representatives and in the Senate – U.S. President-elect Barack H. Obama II will have the ability to pursue more or less any policy he wants.

For investors who have been trying to analyze the economic outlook for the New Year, the election of U.S. Sen. Obama (D-Ill.) provides a major piece of the forward-looking jigsaw puzzle that these analysts hope to assemble. That’s because the likely trends of the United States and other economies around the world – and the relative success of different sectors within those economies – depends crucially on who’s in the White House, what policies they have, and how effectively they can pursue those policies.

Only one thing keeps the triumph of the incoming Democratic president from being totally complete: The Republicans appear to have held onto 41 Senate seats, enough to prevent the Democrat majority from overriding a united filibuster. In practice, however, there are few issues on which the Republicans will be completely united. Thus, on only a few “litmus test” issues – such as the “Employee Free Choice Act,” which removes the secret ballot from union elections – is this filibuster threat likely to be effective.

Obamanomics: From the Environment to Health Care

A review of President-elect Obama’s economic policies – characterized by the term, Obamanomics – clearly offer profit opportunities. Let’s take a closer look at some key areas to consider in 2009.

In the economics area, Obama’s two signature policies are a promise to institute a “cap-and-trade” system of carbon emissions permits to combat global warming, and a substantial expansion in state healthcare provision, notably to include universal healthcare provision for minors.

On the energy front, the support of U.S. Sen. John McCain (R-Ariz.), for the “cap-and-trade” system will make it much easier for Obama to pass legislation quickly, probably in the first half of 2009. Under Obama’s proposed legislation, emission permits will be auctioned to utilities and other businesses with substantial carbon emissions. This has the advantage of being more of a free-market approach than McCain’s plan to give away the permits for free, which would have required the creation of a huge government bureaucracy to decide who would get those permits.

Sign up below… and we’ll send you a new investment report for free: “Credit Crisis Report.”

Even so, Obama’s approach has the disadvantage of imposing gigantic new costs on utilities and other carbon emitters. Indeed, Obama himself has said that new coal-fired power plants would become hopelessly uneconomic under his plan – chiefly because of the costs of the emissions permits they would need. That suggests that nuclear power plants (which he does not oppose) would account for the majority of new power-station construction during the Obama presidency – although solar, wind and other power-generating technologies that look pretty and can be made to work also will fare well.

The corollary of Obama’s emissions permit program, therefore, is that an investor should sell coal-producing companies and coal-fired electric utilities, and invest in nuclear power stations and uranium-mining companies. In principle, there should also be opportunities in the solar- and wind-power sectors, but the “new energy” fad of the last couple of years has already driven their valuations to uneconomic levels.

On the healthcare side, investment recommendations are more difficult to isolate. Generally, Democrats are skeptical of the patent protections enjoyed by pharmaceutical companies – as well as the high prices those protections create – so the major manufacturers of patented drugs should be avoided.

Conversely, the producers of generic drugs appear poised to benefit from the increased spending on healthcare – especially the manufacturers of pediatric healthcare products, including pharmaceuticals – should benefit from the Obama program’s emphasis on children’s healthcare.

Financial Crisis Redux

Of all the questions investors will have about the New Year – following Obama’s victory – is what the new administration will do about the current financial crisis.

A federal bailout package – consisting chiefly of spending increases – seems almost certain in the short term; that will cause the federal deficit to balloon even more than it has already, will make U.S. Treasury bond financing increasingly difficult, and will further stoke inflation. In those circumstances, avoid Treasury bonds, except the inflation-protected buying Treasury Inflation Protected Securities (TIPS), the principal and interest of which are linked to the Consumer Price Index (CPI). TIPS currently have an attractive yield around 3.0%.

It seems likely that an Obama administration will tend to impose costs on the financial-services sector in return for the bailouts it receives – perhaps, for example, banks will be required to funnel lending into low-income areas, or toward other chosen beneficiaries. Limits on financial-sector remuneration also may make it difficult for the major banks to do business, particularly in the trading area. The Democrats have a more aggressive attitude toward “predatory lending” than the Republicans, and will undoubtedly find innumerable examples of such lending in the mortgage and credit card area over the next few years, which they will wish to punish. Hence, financial sector investments should be generally avoided.

Potential Profit Plays

On the other hand, both Obama and the Democrats seem more likely to propose bailouts for states and municipalities that find themselves in budgetary hot water because of the recession that’s sure to come (if it’s not here, already). Thus, municipal bonds, which carry a considerable credit risk under a tight-fisted Republican administration, may be thought of as less vulnerable to default under an open-handed Democrat administration with sympathy for the issuer’s problems, particularly if that municipality represents a core urban Democratic constituency.

When New York City got in trouble, U.S. President Gerald Ford – the Republican who succeeded the disgraced Richard M. Nixon – took an unsympathetic attitude and The New York Daily News captured his perceived attitude with the headline: “Ford to City: Drop Dead!” No such episode will occur under the urban-oriented, free-spending Obama!

And that makes munis a “Buy.”

Also in the “Buy” category are automobile and auto-parts companies. No matter which candidate ended up winning Tuesday, the victor would almost certainly decide to bail out U.S. carmakers, as well as the suppliers that rely on them. After General Motors Corp. (GM) was rebuffed in its bid for aid by the Bush Administration, the bailout of U.S. carmakers is now being billed as a top priority for the incoming President Obama.

Automakers such as GM and Ford Motor Co. (F) benefit from being the headliners in an iconic U.S. industry – especially because it’s one that employs lots of potential Democrat voters in industrial states and suffer from international competition that increasingly riles the more protectionist Democrats. A bailout is thus inevitable, probably without involving the automobile companies in a Chapter 11 bankruptcy. And that makes their shares worth a “flutter.”

President-elect Obama’s supporters celebrated ecstatically Tuesday night. Investors should be more skeptical. But looked at carefully, an Obama administration – and Obamanomics – would still seem to offer opportunities for profit in the New Year.

[Editor’s Note: Money Morning’s "Outlook 2009" series is a follow up to our 2008 forecasting series, which looked at nearly two-dozen topics, and was read by tens of thousands of readers, making it one of our most popular features of the past 12 months. Indeed, the series was ultimately republished as Money Morning’s first book: “The Essential Investor’s Playbook for the Next 12 Months." Rest assured we have even more ambitious plans for this year’s “Outlook” series – including a forecast for the U.S. economy by R. Shah Gilani, a retired hedge-fund manager and noted credit-crisis expert, as well as an analysis of the outlook for the global stock markets by Keith Fitz-Gerald, a former professional trade advisor who is now a well-known market commentator, as well as Money Morning’s Investment Director. Other topics we’ll be covering will include gold, oil, commodities, housing, China, sovereign wealth funds, biotechnology, income investments and alternative energy. The author of this first “Outlook 2009” installment, Contributing Editor Martin Hutchinson, was the correspondent who penned Money Morning’s “Election 2008” series. At the very start of the presidential campaign, Hutchinson personally interviewed the economic advisors for candidates John McCain, Barack Obama and John Edwards, and very early on concluded that out of the entire field of presidential hopefuls, Obama and McCain would offer the best profit opportunities for investors.]

 News and Related Story Links:

• Money Morning Presidential Election Series:
  Election 2008: Taking a Financial Flyer on the Race for the U.S. Presidency.
• Wikipedia:
  Barack H. Obama II.
• Money Morning News Analysis:
  Bailout Plan Forcing U.S. to Borrow $1.4 Trillion, Creating a $1 Trillion Deficit.
• Wikipedia:
  Filibuster.
• Money Morning Presidential Election Series:
  Election 2008: A McCain Victory Won’t Mean Same Old Republican Story.
• Wikipedia:
  Employee Free Choice Act. 
• Center for Responsible Lending:
  Seven Signs of Predatory Mortgage Lending.
• Wikipedia:
  Energy Trading/Cap-and-Trade System.
• Yahoo! Finance Education Center:
  How U.S. Treasury bonds Work.
• Money Morning Special Investing Report:
  Treasuries May be no Safe Haven in This Stock Market Storm.
• TreasuryDirect.gov:
  Treasury Inflation-Protected Securities (TIPS).
• InvestingInBonds.com:
  About Municipal Bonds.
• Whitehouse.gov:
  Gerald Ford.
• Money Morning News Analysis:
  Government Won’t Extend $700 Billion Bailout Plan to U.S. “Big Three.”