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Financial Predictions for 2009
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
These predictions were made in December 2008.
the political cycle, with Barack
Obama about to be inaugurated as President of the United States, has led
to a guarded sense of optimism. I think there is reason for hope, but
the volatility and tough times will continue for a while. Obama will
need to make some tough decisions, and the tone he sets regarding
personal accountability versus political expedience will last for years.
World economic cycles play out over many years. While the US has had
many financial missteps lately, there do not appear to be other
countries doing better. We are entering an era where saving will become
more popular. This is a positive long-term development, but in the
short-term could lengthen the tough times. Fiscal spending will help,
but these funds will need to be spread around. The economy is likely to
contract until someone figures out a way to loosen the credit markets.
Businesses need loans to grow. These loans need to be available for
small businesses as well as large, publicly owned, firms. The budget
imbalances will require future tax increases, and there will need to be
a balance between tax collection and incenting people to work. The
Beatles wrote Tax Man for a reason. British rates were 90% at the
highest levels and there was not much incentive to work. There are many
physical disasters that could happen, and one could stimulate the
country to work together and move past the current crisis. I continue to
be worried about unintended consequences of actions today, with the FHA
and FHLB on the radar. I expect the economy to struggle but start to
recover by the end of 2009, with the stock market starting to recover in
the second half. Inflation will remain low, although the seeds of
inflation are already planted.
- Results: Correct.
I think I got this one pretty much right. Obama took us from the
brink of systemic ruin, but did so using political expediency, in
particular with union issues and by staying away from tort reform
when redesigning the health care system. It looks like something
will now pass, but it will not reduce costs. More on that later. The
economy has rebounded from the absolute freeze up that was the
latter part of the Bush administration. Jobs are not growing yet,
but the stock market has had larger positive gains than I expected.
The dollar’s fall was interrupted by the flight to safety and the
fact that other countries were just as bad off as the US. The
long-term trend is still down. The loan market is still locked up,
but are starting to thaw. Some markets are changed forever, while
others will evolve to a less chaotic state. FHA is already on the
hot seat with some worried they will be the next Fannie and Freddie.
- Comments: the
seeds of inflation have indeed been sown, but it will take time for
them to grow. This reminds me of the guns and butter arguments from
the late 1960s that led to high inflation a decade later. Writing
this newsletter is helpful as it forces me to think long-term. When
the world seems to be coming to an end a longer time horizon
provides a competitive advantage.
- Volatility will stay
above long-term averages, although it should fall back from the current
40. The new norm will be about 20 versus the historical 15-16.
- Results: Correct.
Volatility has fallen back to the 20-25 range much more quickly than
I expected. It is currently at the lower end of this range.
- Comments: it makes
no sense to me that volatility should be back at historical ranges
at this point in time. There is a market imbalance, but is it due to
hedge fund problems and reduced trading or some other reason?
- Oil will rise above
the current range of $40 per barrel. I believe its long-term mean
reversion rate is in the $80-110 range, but recent volatility has made
any predictions very risky. If oil prices do not rise, political
instability in Russia and South America will quickly follow in the next
couple of years.
- Results: Correct.
Just as $140 per barrel was a market anomaly, so too was $40 per
barrel. Currently prices are above $70.
- Comment: As the
world economy improves the price of oil should increase. The
interesting dynamic will be whether natural gas takes market share
as a green substitute as well or if the world continues on as if
nothing has happened.
- Credit risk will
continue to play out – commercial mortgages and junk bonds will
especially impact smaller firms, while CDOs and credit default swaps
continue their negative cycle. Hospitals are at risk in 2009, along with
municipalities who have offered more than they can pay in benefits
(especially defined benefit pension schemes and post retirement medical
benefits). Junk bonds might be worth looking at by the end of 2009 as
spreads will be wide and the credit cycle may be about to improve.
- Results: Correct
for the most part. Commercial mortgages continue to be hit hard and
several REITs have gone bankrupt. Municipalities are now recognizing
their difficulties, driven by defined benefit pension plans,
politicians who see no risk in problems that occur after their watch
is completed, and unions who overreached their needs. The next step
is for local newspapers to use investigative reporting to make the
process more transparent, and this has started. Post retirement
benefit costs have not been showcased yet. CDOs have been a
disaster. Junk bonds rebounded earlier this year.
- Thoughts on Credit
- Why didn’t the
government place capital in the shells of insolvent banks? By
giving the money to undercapitalized banks, it was not
surprising that they used the money to maintain their ratings.
The new leaders at Treasury (mainly Geithner) need to think
outside the cube.
More is coming out now about how quickly decisions were made
and how little thought went into them.
- AIG – why were
these CDS contracts not allowed to go belly up? Anyone who
entered into them accepted counterparty risk. The American
taxpayer has already paid in $150 billion. Certainly closing the
contracts at the point of bailout could have been done. Who will
feel badly for the hedge funds that would have made more
profits? The problem is that banks also were heavy buyers and
the government was already committed to keeping them solvent.
The government seems to operate as if defaults are not part of
our system. Capitalism needs defaults in order to work. This
does not mean that workers should not be given help to be
retrained. Personal auto industry story – growing up in Detroit
and hearing that people were making lots of money to turn a
wrench, I was always amazed that they did not save more money or
work on other skills for when the gig was finally up. It was not
sustainable, and the car companies deserve no sympathy from the
American public. The movie Tucker shared a typical example. John
Dingell (Democrat from my home district in Michigan) married a
Ford lobbyist yet claimed this did not impact any of his votes
in Congress. Also, why were employees from Goldman Sachs present
at high level Treasury meetings in 2008? The perceived ethics
are questionable, especially when Treasury Secretary Paulson was
formerly Chairman and CEO at Goldman Sachs.
Not sure what I could add here, except to express my
dissatisfaction that it was not hedge funds primarily but
investment banks that received my tax dollars. I still think
that AIG will be allowed to go under once Goldman Sachs has
- Bank consolidation
will continue, with mid-sized and smaller banks merging to gain
economies of scale and consumer trust.
- Results: Correct.
TARP money has recently been paid back, but the FDIC is under water
and consolidation is occurring as the FDIC uses tax dollars to pay
off bad debt and sells bad banks to other banks.
- Comments: We have
a ways to go with this, especially if the agriculture cycle go
consolidation will accelerate, with household names as well as smaller
firms being merged into other firms. Larger, supposedly sophisticated,
firms accepted the investment and product risks knowingly, and many
smaller firms were led along with the crowd to the cliff by statements
like “all the sophisticated insurers are doing this”.
- Results: Wrong,
but early. Many insurers were up for sale, but the problems were
wide spread and there were no buyers. Insurers, especially those who
write variable annuity business, had little capital to spend.
- Comments: As the
markets rebound for insurers, consolidation will accelerate.
Expenses are too high and industry overhead will need to be reduced.
Principle-based approaches to capital (PBA) will help this to occur
if it is put in place.
- The dollar will revert
to its trend and fall based on imbalances in our trade and borrowing
policies. Other scenarios focus on countries heavily invested in
dollars, such as China, Japan, and the oil exporters, choosing to dump
them. US Treasuries would then spike and the US economy could find
itself in a vicious cycle resulting in stagflation. This would take
several years to play out and would impact the stock market heavily.
Various energy subsidies will play out here, from ethanol subsidization
to wind farms, with unintended consequences following the well
intentioned efforts of politicians (latest example is forcing auto
makers to make “green” autos). Watch for others to make vehicles that
people will buy, making it even tougher for the auto industry to
- Results: Wrong,
but early. This hand will play out over a decade, not in one year.
- Comments: Cash for
Clunkers is a great example of a program with unintended
consequences. While there is a group of people that only buy new
vehicles, what are the people supposed to do that normally buy the
cars that were destroyed? They will either wait, keeping their
previous super clunker, or buy something older. That will clean the
- Political instability
throughout the world will be a problem, driven by the liquidity crisis,
price of oil, and/or terrorism.
- Results: Wrong.
This has not been as big a deal as I expected. The crisis has led
nations to rally around their existing leaders. If the economy
improves around the world this might come into play again.
Emerging Risks - Concerns
- Can an internal CRO be
strong enough to stand up and be counted, or will fears for their job
keep them “in line”. Every firm needs a Chief Skeptical Officer.
- Comments: I’m not
aware of examples where contrarians were welcomed as adders of
- Tort reform needed –
the world continues to become more litigious at its peril
- Infectious disease -
increased resistance to antibiotics (e.g., tuberculosis, staff
infections or pneumonia)
- Comments: closer
- Global warming –
unexpected side effects like new viral/bacterial attacks, along with
coastal flooding and increased hurricane activity
- Comments: More
studies but Copenhagen conference was a dud.
- Comments: ever
- Earthquakes – the US
is overdue for a major quake on the west coast and other areas not
normally expected for seismic activity are well into their cycle
- Comments: limited
US impact in 2009.
capital in the financial services industry will be abused by some and
not always caught initially by peer review. Currently it is doubtful
that the US will have a major influence on PBA worldwide due to the
NAIC’s political games.
- Lots of games but
nothing has passed yet. SOA research project will help companies
better understand the implications of implementation.
- Home building sector
will finish bottoming and level or slightly improve over the next couple
of years depending on interest rates (up would be worse). It is probably
time to buy stocks in materials firms that serve this market and have
low debt. Discussion will start in the next couple of years about a tax
overhaul that could include a reduction of the mortgage deduction.
Perhaps the AMT will form the model tax law and many deductions will be
eliminated. While this might be good incentive, it will hit the home
- Comment: housing
market is bottoming but there are some regions with huge supply.
Lower end of the market will come back first.
- US political
environment – can they say no to anyone requesting a bailout?
- Comment: they
- Malthus – too many
people, not enough food – will good intentions of the rich to save lives
in the 3rd world lead to mass starvation or unstable regions?
- Comment: still a
future risk despite genetically modified seeds.
- Economy – risk of
stagflation and the lack of an internal hedge for investors holding both
equities and bonds – bonds seem particularly challenged right now as
rates are low
- Pandemic influenza –
business continuity, impact on small businesses, combination with
malaria/AIDS in Africa, Tamiflu overuse – watch for the first cluster
that involves a doctor or nurse to implement a preconceived plan
- Comment: pandemic
hit in the spring but so far has shown to be low virulence. Hitting
young, strong, and pregnant as expected.
- Counterparty risk –
will losses be allowed? AIG showed where the credit default swap market
concentration was to be found. Many hedge funds were swimming naked as
the tide went out. Bernie Madoff led a Ponzi scheme right under the
noses of many of the world’s largest investors. Much of the economy
continues to be concentrated in a few parties, and now the American
taxpayer is one of them. This is not a positive consequence and will
lead to more contagion in the system and more correlation in the tails.
More qualitative analysis needs to be done by financial experts rather
than relying on models that aren’t accurate in the tail or focus on top
line rather than bottom line growth. Relying on Black-Scholes models to
both determine value and confirm prices has been a disaster. If you
can’t understand a risk without complicated mathematics it should be
concentration risk continues to expand.
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.
An estimate of fair value of these liabilities should be calculated and
shared with stakeholders. Firms had the opportunity to get out of DB
schemes when the stock market was up for 5 consecutive years. Why more
did not do so shows how little scenario planning was being done.
Municipal plans especially are going to default.
- Comment: starting
to see DB plans shut down again.
- Demographics –
designing products that are economically sound to both policy owner and
- Comment: note that
the new variable annuities do not promise so much
- 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. Focus on
transparency and peer review.
- Peer review – how to
make it extend beyond a regulatory requirement to help manage the
business by identifying and exploiting advantages
- Comment: the past
year has shown the necessity of doing this. Transparency in the
strategic planning process is key.
- National health care –
need actuarial solutions – this may move in 2009 as part of the fiscal
- Comment: indeed it
moved, but I don’t see where actuaries were engaged in either this
or the systemic risk “solution”. Many in the industry have well
thought out solutions, but unfortunately politicians are more
interested in listening to those with more money to share.
information provided in this newsletter is the opinion of Max Rudolph and is
provided for general information only. It should not be considered
investment advice. Information from a variety of sources should be reviewed
and considered before decisions are made by the individual investor. My
opinions may have already changed, so you don’t want to rely on them. Good