Trends I'm Watching

How the Housing Downturn Will Affect the Rest of the Economy

Trends: The housing downturn will cause rising unemployment, a deep recession in the housing market, a consumer under siege, and a visibly slowing economy.

John Maudlin at InvestorsInsight predicted the credit crunch from subprime mortgages many months ago, when most experts said the damage was contained. Here are his predictions for the effects. Excerpts below.

Link: InvestorsInsight : Thoughts From The Frontline

First, rising home values have allowed homeowners to use their homes as an ATM through mortgage equity withdrawals, which have added almost 2% to GDP annually over the last five years. That is now evaporating.

Secondly, falling home construction and lower home sales means fewer jobs not just in the direct home building market, but in the parts of the economy related to the home building markets, like mortgage brokers, real estate agents, hardware and furniture, etc. As an example, Countrywide announced a planned 10-12,000 person lay-off, when just a few weeks ago they were thinking of expansion, as they now think new mortgages may drop 25% in 2008. Fewer jobs mean lower consumer spending.

Consumers are not going to spend as much due to the wealth effect. If you feel your house was going to be a major part of your retirement, and now the value is going down, you are going to be more cautious and actually think about saving. This has been a dangerous prediction for 50 years, but I think consumer spending, some 71% of the US economy, is due to slow down. Year over year growth could drop below inflation later this year.

Further, with all the additional homes coming onto the market due to foreclosures, hone values are going to drop even more, and new home construction, which peaked at an annual run rate of 2,000,000 homes per year, is likely to fall to less than 1,000,000. We are currently at a level of 1,400,000, so we are not yet close to the bottom.

Eight Global Trends

Trends: The ascension of the Chinese, Indian, Russian and Brazilian middle class, the economic rebirth of Europe, the world baby-boomer binge, the rise of fundamentalist Islam and radical Islamic terrorism, carbon-emission management, the new oil/energy age 2008-2015, mega-technology, and the $2.5 trillion sovereign wealth fund.

Tobin Smith of ChangeWave Investing lists eight global trends at MSN Money. Excerpts below.

Link: Tobin Smith Journal.

...the most powerful transformations in the global economy:

1. The ascension of the Chinese, Indian, Russian and Brazilian middle class. This is the most powerful transformative, mega-secular macroeconomic event, with roughly 75-100 million new active consumers coming into the world economy yearly. Trillions of dollars of new consumption is turning export-based economies into consumer economies, a world first. The U.S. is only 20% of the world's GDP now, and falling. That's good -- because the pie is getting bigger for all.

2. The economic rebirth of Europe. The birth of U.S.-style capitalism, corporate governance and election of pro-capitalism leadership in Germany, Central Europe and even FRANCE!

3. The world baby-boomer binge. The world's 225 million baby boomers are hitting their PEAK earnings and wealth accumulation period from 2008 to 2015.

4. The rise of fundamentalist Islam and radical Islamic terrorism. Hundreds of millions of human beings now live in Islamic nonsecular countries under nonsecular governments.

5. Carbon-emission management. The adoption in Europe, Japan, Canada, California (more to come) of carbon-emission controls and credits.

Six market waves

Trends: Alternative energy, Mine Resistant Ambush Protected (MRAP) vehicles, clean water, biotech, 'Chindia' middle class, and jetliners could be fertile ground for investing in the near future.

Tobin Smith describes six major waves that ChangeWave Investing has identified for investers looking for market gains. Excerpts below.

Link: Tobin Smith Journal

1. Alternative energy wave

2. Mine Resistant Ambush Protected (MRAP) vehicles wave

3. Clean water wave

4. Biotech wave

5. 'Chindia' middle class wave

6. Jetliner wave

These markets don't come all the time. It's certainly here for the next two to three years, but beyond that I couldn't tell you.

We are guided by our ChangeWave Alliance research as we continue to expand our horizons -- meaning we're on the lookout for the niche companies and sectors in which we can double our money every two to three years.

I've got to be a stock market cheerleader because you're going to hear all sorts of bad news this summer about subprime loans. You know we're going to get a pullback, but it's that pullback that gives you the next great buying opportunity.

The way you make market-doubling and market-tripling returns every year is to be ahead of the crowd.  You've got to be in the right places at the right time at the right price.

Pareto's 80/20 Rule Expands Its Applicability

Trend: The normal curve may not be the best model for predicting market behavior in the future.

John Hagel writes in his blog that our reality is shifting from a "normal curve" (Gaussian) world to an "80/20 rule" (Pareto) world, with profound implications for business. He cites work by McKelvey and Andriani about the need to change our mindsets to adapt. Excerpts below.

Link: Edge Perspectives with John Hagel: The Power of Power Laws.

In a world of power law or Pareto distributions, extreme events become much more prominent.  Extreme events can take many forms.  They can be sudden and severe disturbances like a class 9 earthquake or a financial meltdown like the one that occurred in US stock markets in 1987.  As McKelvey and Andriani observe, “the lesson that we can draw . . . is that extreme events, which in a Gaussian world could be safely ignored, are not only more common than expected but also of vastly larger magnitude and far more consequential.”

Our institutions (not just businesses, but also educational and governmental) are largely designed for a Gaussian world where averages and forecasts are meaningful.  As a result, we have evolved a sophisticated set of push programs that have delivered significant efficiency.  In a world of sudden, severe and difficult to anticipate shifts, push programs become much less viable and we need to become a lot more creative in terms of designing pull platforms.

Housing: Tighter lending standards and increased regulation

Trend: Tighter lending standards and increased regulation could change the housing outlook for some years to come.

InvestorsInsight: Thoughts From The Frontline features PIMCO's bond chief Bill Gross, who writes that interest rates will decline and bonds be in demand over the next few years.

Link: InvestorsInsight : Thoughts From The Frontline

It will not be loan losses that threaten future economic growth, however, but the tightening of credit conditions that are in part a result of those losses. To a certain extent this reluctance to extend credit is a typical response to end-of-cycle exuberance run amok. And if one had to measure this cycle's exuberance on a scale of 1-10, double-digits would be the overwhelming vote. Anyone could get a loan because shabby credits were ultimately being camouflaged within CDOs that in turn were being sold to unsophisticated foreign lenders in need of yield as opposed to ¼% bank deposits (read Japan/Yen carry trade).

As past marginal buyers are forced to sell their home to prevent foreclosures, so too will future marginal buyers be restricted from buying them. No one really knows the amount that homes must fall in order to balance supply and demand nor the time it will take to do so, but if one had to hazard a conclusion, it would have to be based in substantial part on affordability statistics that in turn depend on financing yields and home price levels .... ...homes are likely 15-20% overvalued (3 years x 5%+ annual overpricing).... If mortgage rates don't come down, home prices need to decline by 20% in order to reach prior affordability levels. If rates do come down, home prices will drop less.

And while the Fed may be willing to allow U.S. homeowners to suffer a little pain as indeed they have in recent quarters, a double-digit decline would risk consequences that few central banks would be willing to underwrite. So a forecast of home prices almost implicitly carries with it a forecast for interest rates. To prevent a double-digit decline in prices, PIMCO's statistical chart suggests that mortgage rates must decline a minimum of 60 basis points and the sooner the better. The longer yields stay at current levels, the more downward pricing pressure will build as foreclosures/desperate sellers dominate price trends as opposed to prospective buyers. While the Fed, as pointed out in last month's Investment Outlook must be cognizant of an array of asset prices in addition to housing, homes are the key to future equitization trends, and fundamental therefore to the outlook for consumption.

...Investigate the Fed's own study, written in September of 2005 (Monetary Policy and House Prices: A Cross-Country Study) covering housing cycles in aggregate and individually for 18 countries over the past 35 years. This study's important conclusion for PIMCO and our clients is that if home prices in the U.S. have peaked, and are expected to stay below that peak on a real price basis for the next three years, then the Fed will cut rates and cut them significantly over the next few years in order to revigorate an anemic U.S. economy. Strong global growth (not part of this study's assumptions) may temper historical parallels and provide a higher floor than would otherwise be the case. Nonetheless, prices for houses that I can see and touch every day outside my office are morphing with bond yields inside my computer screen to produce a reality show that speaks to an ongoing bond bull market of still undefined proportions.

ROI Forecasts

Predictions:  Compounded expected returns: 7.5% for U.S. equities, 7.2% for non-US stocks, 5.6% for bonds, and 6.5% for real estate.

James Picerno interviews Armand Yambao, who heads up financial modeling at EnnisKnupp. EnnisKnupp & Associates (EnnisKnupp.com), a Chicago institutional-investment consultancy that oversees $700-billion-plus in assets for the likes of pension funds and foundations. The 25-year-old firm is a respected force in the business of advising big money, and so it has learned much about making forecasts that are prudent yet practical for clients.

Link: Archive of Wealth Manager stories by James Picerno

EnnisKnupp’s latest semi-annual outlook, published midway in 2006, has a forecast for compounded expected return for U.S. equities at 7.5 percent a year. How does that compare with history? If you just look at historical equity returns, you’ll come up with something like a 10 percent to 11 percent annual return, and so our 7.5 percent forecast for U.S. equities is less than what backwardlooking expectations suggest.

The market’s implied outlook for inflation for the next 10 to 30 years was recently around 2.5 percent based on inflation-indexed Treasuries. Another data point comes from the Blue Chip Economic Indicators newsletter, which also had a forecast of 2.5 percent inflation.

We’re expecting a 5.6 percent compounded annual return for bonds over time.

For non-U.S. stocks, our long-term expectation is a compounded annual return of about 7.2 percent, or a bit lower than the 7.5 percent for U.S. equities. The reason for the slightly lower performance forecast is higher volatility.

For a generic real estate investment, the outlook is in the range of 6.5 percent on a long-term basis. Our long-term return expectation for real estate is somewhere between U.S. bonds and U.S. equities, and that’s how we come up with a 6.5 percent compounded return that’s between those two asset classes.

Historical returns aren’t a very good predictor of future returns. If you did a back test and relied only on history, you’d do a poor job. Let’s say that equity performance skyrockets in 2007.

Q: What’s the bottom line?

A: Investors shouldn’t blindly rely on equities to satisfy investment goals. We’re not saying avoid equities; it’s more about understanding the risks.

Three niches investors should watch

Trends: Technology advances in battery power, power control, and GPS cell phones have great potential for significant growth in the future.

Jim Jubak at MSN Money describes three trends that may be where the next tech stock rockets start their climb. Click on the link below to see eight stocks he recommends. Excerpts below.

Link: 8 future tech-stock rockets - MSN Money

So where's the buzz, the fizz, the flash, the dazzling profits in tech stocks?

The potential rockets, I'd argue, are companies doing business in what are now emerging niches in the technology market. Right now they're small in revenue with products that still haven't met wide adoption. And they face the very real possibility that, once they prove a market, bigger competitors will jump in to steal, if not their thunder, at least their profit margins.

But these companies all have major economic and technology trends at their backs that give them the potential to capture a big share of a future market that now barely exists. No one column can capture all of the trends that could produce tomorrow's big technology markets. But today I'll describe three trends and give you the names of eight companies hoping to capture a share of those trends. Using these examples as templates, you can then go looking for more technology trends -- and stocks to ride them -- on your own.

Look for small, immature companies in markets that are so new that the price premium on a new product is very high and has the potential to last longer, since the big companies with their advantages of scale haven't yet put a foot into the market.

3 niches investors should watch

Here are three technology niches that fit that bill in my opinion.

1) Batteries: better things in smaller packages

There are two takeaway lessons from the fires that forced Dell (DELL, news, msgs), Apple Computer (AAPL, news, msgs) and Toshiba (TOSBF, news, msgs) to recall almost 10 million lithium-ion batteries.

• Current battery technology has hit a wall. Lithium-ion battery technology, the technology of choice at the moment since it combines high power, fast recharge and steady voltage, is now 30 years old and it is showing signs that it can't meet the relentless demands from consumer electronics makers and customers for more and longer lasting power in smaller and smaller packages. As more and more powerful lithium-ion batteries are squeezed into smaller and smaller packages, the likelihood that batteries will overheat and burn increases.

• The demand for battery power for mobile devices is huge -- and growing. Lithium-ion batteries alone powered 50 million laptops, 800 million cell phones and 80 million digital cameras sold in 2005. And this doesn't count the lithium-ion and older nickel-cadmium batteries in use in devices such as cordless power tools.

2) More power from better power control

It's easier to understand this from an example than in the abstract. When Sony wanted to create a line of ultraslim digital cameras, the tough part was getting a battery powerful enough to run the camera inside a case less than an inch thick. The solution was to package a smaller and slightly less powerful battery with its own microprocessor. The chip constantly monitors the camera's energy use and the battery's energy output to minimize waste and help a smaller battery do the job of a bigger one. Power-management chips are likely to see hot growth over the next decade in mobile products, where the goal is to get more power and longer life out of a battery, and in the economy as a whole as higher energy prices make doing more with less energy a big cost saver.

3) Location, location, location

Not physical real estate mind you, but the ability to pinpoint your position in real space electronically using the Global Positioning System (GPS). GPS device maker TomTom (TMOAF, news, msgs) just raised its forecast for sales of standalone GPS devices to 10 million units in 2006, up from 4.6 million units in 2005. That snazzy 122% year-to-year growth, however, isn't the biggest prize in the GPS sector. The ultimate good news is that more and more wireless phone companies are inching closer and closer to adding full GPS capability to their phones. The wireless phone market, at a global 800 million units in 2005, dwarfs the standalone GPS segment.

Predicting the Future: Trends for Success

Start-up CEO lists some trends that will affect business in the coming few years. Click on the link below for more detail.

Link: Start-up CEO » Predicting the Future: Trends for Success

Positive Trends:

1. Cost of starting a business plummet

2. International Consumption Soars

3. The emergence of the Hispanic demographic

Negative Trends:

1. The housing slowdown will halt consumer spending to a crawl and drive the economy into a recession.

2. Iran and N. Korea build a nuclear arsenal

3. Poor get poorer

Trends for a long-term investing strategy

Jim Jubak at MSN Money describes the trends that will influence investments in the long term.

Source: Turn short-term fear into long-term profit - MSN Money

The developing world is growing richer

Oh, not all of it. But countries such as China, India and Vietnam -- more than 2 billion people just in those three, and many more in other developing nations -- are growing their economies at rates double or triple the 3% growth rate for the developed world projected by the Organisation for Economic Co-operation and Development. That will add hundreds of millions of consumers to the global middle class who will demand middle-class products and services such as life insurance, home mortgages, hotel rooms and cars.

Demand for commodities will continue to exceed supply

A fast-growing developing world has created demand for commodities that global commodity producers in industries from oil to copper to coal to iron (and don't forget water) are having a tough time meeting. That has produced what some Wall Street investment houses are calling a "supercycle" boom in commodities prices.

We've seen the low in the inflation cycle

Although it will be a very odd kind of inflation, higher energy and commodity prices will bleed through into the core inflation rate. "Loose money" policies in China and the United States and the need to recycle petrodollars will keep the globe awash in cash, although not as much as at the peak in 2005-2006. However, thanks to the surplus production capacity added to the global economy from China, India, et. al., the prices of manufactured goods aren't likely to climb very fast.

The dollar will continue to slide

Probably not as fast as the doomsayers now predict because Japan and the European Union have their own problems that will keep pressure on the yen and euro. But thanks to our huge trade deficit and the utterly feckless fiscal policy in Washington, the world isn't exactly clamoring to hold more U.S. dollars.

Baby boomers will be retiring

The U.S., with its combination of great wealth and relatively high rate of population increase (thanks to a relatively high birth rate and relatively open immigration policy), might be best positioned to muddle through. But it will require the baby boomers to cash in real estate by downsizing to cheaper geographies, and require that those boomers admit that the country can't afford to spend every last cent on prolonging their lives.

Best bet on the demographics of U.S. real estate: banks and land companies in low-cost retirement areas such as the Carolinas, Georgia, Arkansas and parts of Texas.  And if you're cynical about any attempts to control health-care costs, as I am, look to companies that profit from the chronic diseases of old age.

10 Surprises for 2006

Michael Covel lists Byron Wien's 10 'surprises' for 2006.

Link: Michael Covel is the Author of Trend Following: Official Website

At his keynote last week in Austin, Byron Wien of Pequot Capital laid out his 10 'surprises' for 2006:

1. Crude goes to $80, but inflation stays low.
2. S&P declines 5%.
3. Fed funds moves to 5%, but US treasury yields stay at 4.5%.
4. Large cap stocks fail to gain ground.
5. Price of gold declines to $425.
6. Dollar gains another 10% against yen and euro.
7. International markets correct.
8. China keeps their currency undervalued.
9. Stock markets are sent reeling by pandemic or another US terrorist attack.
10. Mitt Romney is 2008 GOP candidate and Hillary is 2008 Democrat.

Wien said that he usually predicts 6-7 correct every year going back 20 years.

15 New Tech Concepts For 2006

Predictions: Popular Mechanics' 15 Tech Concepts You'll Need To Know In 2006

In the January, 2006 issue of Popular Mechanics, Alex Hutchinson describes 15 Tech Concepts You'll Need To Know In 2006.

Source: PM: 15 New Tech Concepts For 2006

1. Body Area Network (BAN)
2. Metadata
3. SPIT (SPam over Internet Telephony)
4. Electronic Medical Records (EMR)
5. Perpendicular Storage
6. Nanoparticle Batteries
7. SPIT (SPam over Internet Telephony)
8. Micro Fuel Cells
9. Electronic Medical Records (EMR)
10. Coal Gasification
11. Perpendicular Storage
12. Presolar Interstellar Grains
13. Crime-Lab-on-a-Chip
14. Fiber-to-the-Home
15. Blind-Spot Detection

via Emergic via Slashdot

Worst Case Scenarios for 2006

Trends: $100-a-barrel oil would create a number of negative consequences for the American way of life.

Jim Kunstler's predictions for 2006 are very pessimistic. Read at your own peril.

Source: Clusterf**k Nation by Jim Kunstler : Oh Six

The world oil allocation system is now so fragile that any disturbance in one producing region can send damaging shock waves around the planet....Overall I expect to see $100-a-barrel oil at some point this year.

Our natural gas situation is pretty dire....Even if we have a mild winter overall, there will be spikes of cold. Our production is still crippled in the Gulf. Therefore, I'll predict that methane gas prices will spike above $20 sometime before May.

High gasoline, heating oil, and methane gas prices will absolutely kill the housing bubble for reasons....With the cratering of the housing bubble, the US economy has to fall on its ass. The global economy is likely to fall on its ass, too, since so much of it depends on the decisions of Americans to take out exotic loans for buying houses they can't afford. Large numbers of jobs will vanish in construction, remodeling, real estate sales, and the various mortgage rackets -- those things precisely related to the recent gains in GDP. The sheer falloff in new mortgages will send a tsunami through financial markets addicted to continuous supplies of new "money" to preserve the illusion of expansion.

As America roils in economic pain, factory workers in China will be thrown out of work. They will be extremely pissed off, and as their appeals go unappeased, they might start making political trouble in their country. That could easily stimulate Chinese leaders to divert their nation's attention with a compelling military project -- say some moves into the oil-rich former Soviet lands to China's west. Sooner or later, China eventually will go cuckoo from a shortage of fossil fuels. It only remains to be seen how this will express itself. So far it has only done so in terms of an aggressive outreach in oil contracts with producers like Venezuela and Canada. But those arrangements were based on a peaceful world and a peaceful China.

RED HERRING's Top 10 Trends for 2006

Trends: Red Herring magazine provides a superb list of 10 trends to watch in 2006. Check out the following links: Online Games, Flash Memory, Internet Video, Wireless Net, Precision Drugs, Micro-Payments, Locating You, Sensor Motes, Supply Chains, Nutrigenomics

Source: RED HERRING | Top 10 Trends for 2006

...we gathered empirical evidence and anecdotal insights from venture capitalists, investors, analysts, and the people who put technology to work.

In choosing our trends, we delved into our seven industry sectors, which include biotechnology, IT, alternative energy, and nanotechnology. As with any list we compile, we had to make tough decisions and leave several smart ideas on the cutting room floor. But the big trends endured, like the full-speed rush of the computing industry toward the adoption of inexpensive flash memory.

Along those same lines, we observed that the world of digital music is no longer running from the law. Peer-to-peer networks, once pursued in court by the music industry, sought legitimacy—and dusted off old names like Napster and iMesh as pay-to-play sites. And big media, too, finally showed signs of accepting and grasping the new business models. A telling example was Disney’s deal to let video iPod users download episodes of ABC shows.

One obvious trend in 2005 was the heightened concern with energy issues triggered by the rising cost of oil. The push to embrace clean and alternative energy technologies will surely shape the business and technology landscape in 2006. Mark Rostick, director of strategic investments at IntelCapital Partners, says that big problems facing technology companies like heat and battery limits will start to be solved with better power-saving devices and innovative battery technologies.