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Financial Predictions for 2008 – How Did I Do?
Please remember that these
predictions are for fun. If I knew what was going to happen, I certainly
would not share that information with others! You must make your own
decisions regarding your financial future and not hold others, including me,
responsible for your own results. Enjoy!
Most of these predictions were made
in late December 2007, although final editing did not occur until late
- Economy: there is not
much positive to look forward to in the United States. The consumer has
kept the economy afloat longer than I thought possible. The tide is
likely to go out in 2008. How many consecutive years can the stock
market show positive results? The economy might not formally hit a
recession, but growth will continue below long-term averages. There are
many issues to worry about: budget shortfalls, currency imbalances,
credit issues, uncertain political situation, etc. A physical disaster
could put the economy over the edge. I don’t expect a depression, but
every time the Federal government bails out a bubble “victim”, the
inevitable correction comes closer and will be deeper. The shots to the
economy administered by the Fed late in 2007 should start to take effect
in 3rd/4th quarter 2008, just prior to the
election. A new President will likely reduce military spending and work
toward a balanced budget for the first two years of their
- Results: I got
this one, for the most part, right on. The world economy fell much
deeper than I expected due to the liquidity crisis, so although the
US economy only recently officially was reported in a recession the
monetary stimulus has merely slowed the fall. A short term balanced
budget is no longer in the cards.
- Comment: Luckily,
at least in the US, there have been minimal material physical
catastrophes. Low interest rates are back, but the lack of liquidity
in the system will make it harder for excesses to take hold. There
are still unintended consequences yet to come.
- Volatility will stay
above long-term averages, although I don’t expect it to surge above 30
unless there is an international crisis. VIX is currently at 22.50.
- Results: Partially
right. The VIX hit a high of nearly 90 and was consistently very
high. It was never low. It ended the year at 40.
- Comments: What can
I say? I never thought the VIX could get to 100, but the
international crisis of liquidity was financial rather than
terrorism, oil, or catastrophe based.
- Oil will stay in the
$80-120 range (initial cost is about $95/barrel)
- Results: Wrong. A
barrel of oil was as high as $147 and in the last week of the year
has been lower than $40.
- Comments: Only
with time will we know how much speculation had to do with the high
prices of oil, and how much deleveraging had to do with the low
prices. As alternative sources of energy are not keeping pace with
demand it seems hard to imagine a long-term price lower than $80 per
- Credit risk will
increase with unintended consequences as the sub-prime crisis plays
itself out – watch for commercial mortgages and junk bonds, along with
CDOs and credit default swaps, to struggle in 2008. My worry is what
unintended consequences remain from this bubble. I did not anticipate
the impact on liquidity that required the Fed to bail out the economy
with lower rates, increasing the risk of inflation and lowering the
dollar’s value. I am hopeful that the investment bankers learned more
this time than they did from the manufactured housing debacle that
- Results: I give
myself double credit for this one.
Private equity funds and hedge funds took much of the hit in 2008
but commercial real estate is really struggling now and commercial
mortgages will soon follow. Junk bonds will continue to struggle.
The unintended consequences I worried about a year ago turned out to
be liquidity based. The impact of credit default swaps on AIG and
the insurance industry (and the American taxpayer) is still playing
out, but will lead to consolidation in 2009 and beyond much as we
saw in the banking industry in 2008.
- Comments: More to
- Home building sector
will finish bottoming and level or slightly improve depending on
interest rates (up would be worse) – we’ll try this one again this year.
I think I was just a little early in 2007.
- Results: Wrong.
The home market is starting to bottom in some markets, but I
continue to be early on this one.
- Comments: We sold
a house in 2008, and it took longer and we got less than we would
have expected a year earlier. But we were able to sell it, so my
experience shows the markets have not totally locked up.
- The dollar will bottom
out as oil prices stabilize. Other scenarios focus on countries who are
heavily invested in dollars, such as China, Japan, and the oil
exporters, choosing to dump dollars. US Treasuries would then spike and
the US economy could find itself in a vicious cycle. This may take
several years to play out and will impact the stock market heavily. The
wild card here is the subsidization of ethanol in the United States. If
these subsidies are reduced, the price of oil will temporarily increase,
although that would open a financially feasible market to the oil held
in the Rockies of North America and ultimately create a cap to the
- Results: Oil
prices did not stabilize, partly because the dollar became the
currency for safety and rose after falling for most of the year. The
fact that other countries are just as screwed up economically as the
US kept the dollar from falling further. This long-term trend will
begin again in the next year or two.
- Comments: Ethanol
subsidies drove food shortages in some parts of the world in 2008
and remain a bad idea. We have politically popular alternative
sources of energy rather than that driven by the scientific
community. If we don’t change this other countries will.
- I have a fear that the
Benazir Bhutto assassination was only the first of numerous events over
the next couple of years. Whether this is a repeat of 1968 remains to be
seen. I worry for the Presidential candidates in the US in 2008. We
should pick our Vice-Presidential candidates carefully.
Thankfully this concern has not played out.
- Comments: It was
interesting to see the Republican Vice-Presidential candidate,
Alaska Governor Sarah Palin, become such a focus of the campaign.
Emerging Risks - Concerns
- Pandemic influenza –
business continuity, impact on small businesses, combination with
malaria/AIDS in Africa
- Comments: not much
is happening here, either in preparation or the threat itself.
- Infectious disease -
increased resistance to drugs like antibiotics (e.g., tuberculosis,
staff infections or pneumonia)
- Comments: bacteria
continue to increase resistance to existing drugs.
- Global warming –
unexpected side effects like new viral/bacterial attacks, along with
coastal flooding and increased hurricane activity
capital in the financial services industry will be abused by some and
will not be caught initially by peer review
political pressures tied to AIG and the federal charter discussion
are leading the US to stall out on PBA initiatives. Recent relief
was granted but the standard scenario remains for variable annuity
- Can an internal CRO be
strong enough to stand up and be counted, or will fears for their job
keep them “in line”
- Comments: see my
Chief Skeptical article (December 2008 newsletter) – unfortunately
little progress has been made at large firms (although smaller firms
are making progress)
- Tort reform needed
- US gridlock/
- Comment: the
election is over and Obama is in his honeymoon period. Hopefully his
financial team will do better than their predecessors.
- Malthus – too many
people, not enough food – will ethanol subsidies result in starvation
for the poor?
- Comment: with the
Gates Foundation and others keeping more people alive in third world
countries, how will they be fed? Will there be unintended
consequences of a whole generation of young males looking for
something to do? Will Pakistan become a model for failed states? Are
these policies short sighted?
- Economy – risk of
stagflation and the lack of internal hedge for investors holding both
equities and bonds
- Comment: this year
high quality bonds did better, but the threat of inflation based on
the large stimulus packages will hit bonds hard.
- Counterparty risk – it
is currently so concentrated that one misstep could have major
repercussions. Watch the credit default swap market. Much of the economy
is now concentrated in a few parties. This leads to more contagion in
the system and more correlation in the tails. Financial experts seem to
either rely on models that aren’t accurate in the tail or focus on top
line rather than bottom line growth.
- Comment: 2008 was
the year that this statement came true in a big way. Weapons of
financial mass destruction indeed.
Top Actuarial Issues
- Defined benefit plan
valuation – needs to reflect marketplace economics. Actuaries from other
disciplines should be welcomed, along with those from outside the
profession. Focus should be on cash flows rather than regulatory issues.
- Comment: this is
getting worse, with municipal plans and for profit firms pretty much
toast in the long run. Making assumptions above about 5% for future
asset growth is irresponsible.
- Demographics –
designing a retirement insurance product that is economically sound
- Obesity – how will the
various drivers of mortality and morbidity interact (some good, some
- Lack of rudimentary
knowledge of assets and how to value them – need teaching sessions that
are short of stochastically based financial economics
- This became even
clearer in the past year, and now the Madoff Ponzi scheme has
confirmed how important transparency is. People have made fun of me
for not wanting to invest in mutual funds because I did not know
what was really in them except for certain predetermined dates (end
of quarters, and even that is delayed). For a great example of this,
look at Berkshire Hathaway’s stock price the last two hours of
trading on December 31 and the first two hours in the following
year. Everyone needs a reputable accounting firm to audit them if
they are investing for the public. The marketplace needs to require
- Peer review – how to
make it extend beyond a regulatory requirement to help manage the
business by identifying and exploiting advantages
- Comment: We are
not making progress here yet.
- National health care –
need actuarial solutions
- Comment: It will
be interesting to see if the Democrats use a single payer system as
part of the economic stimulus package.