A US Slowdown is Certain
The chart above shows the stock performance of companies selling consumer staples (necessities) vs consumer discretionaries. When the US economy is expected to grow, the stocks move in tandem. You see a divergence in Jul 2007 and it grows as we get to Dec 2007. What is happening is companies like Starbucks are not doing too well because consumers are spending less on things they don't need.
Why hasn't the US stock market fallen more than it has in anticipation of the slowdown/recession?
1. US corporation except financials will go into this slowdown with the best balance sheet ever. M&A activities are set to continue as we go into 2008.
2. The US expansion was not accompanied by a stock bubble. Stocks were conservatively valued throught the expansion. Post-dot.com investors became very wary of stock bubbles.
3. Stock buybacks have reduced the equity float and corporations have the cash to continue this buybacks through 2008.[Link]
What I fear usually doesn't happen. But things to look out for include runaway inflation which will limit the Fed ability to cut rates and get the economy going. The CPI figures around the world shows the fastest rise in inflation in many years. This was caused primarily by the price of crude oil which threaten to head for the US$100 per barrel mark in Nov 2007. Hopefully, the price of crude cools off and remove the inflation risk.
As Krugman mentioned in his talk, there is an insolvency risk among the banks that can lead to systematic failure. This risk still exists but has abated as banks get infusions from sovereign funds to shore up their capital and there is growing clarity about the losses as banks come forward to write off most of their losses.
The last thing I fear is a longer than expected slowdown. The markets have discounted a 4-6 month slowdown after which the US economy should get its act together. A protracted slowdown can be quite painful for everyone not just investors.
What I've done & Plan to do
In mid-Aug 07, I took the opportunity to purchase a widely diversified basket of Chinese stocks (S-Shares) a segment of the market that I was underweight. They have not performed too badly despite the recent selldown and I anticipate some positive news as the Chinese govt has approved the QDII for Chinese money (savings) to be invested overseas. This money is expected to go into Chinese stocks listed in overseas exchanges (e.g. S-Shares in Singapore). Part of that money should start flowing in as early as Jan 2008.
As the market rebound from its Aug 2007 lows, I also took the chance to cash out of some of the stocks I didn't want to hold. I decided to keep some cash should bargains appear when the US economy slows - so far the US financials look attractive Citibank, Bank of America etc. However, I hate buying at the wrong time so I've a plan to buy at a regular schedule. The other group are the homebuilders - they remind me of our own property developers in 1997-98 when our own property market had a meltdown, whoever survives will go on to thrive as demand returns...the recovery in the US housing market is a long way away but stocks of developers will hit bottom before that. I'm keep a watch on these stocks, while they have fallen 80-90%, I'll probably take my time to get into them.
When one of America's best economists tells you that the future cannot be predicted with any certainty, you better believe it is uncertain. What changes are the views of stock market players who can go from total pessimism to euphoria in a matter of weeks. Investors are put through a rollercoaster ride ...and the recent one was as exciting as the Cyclone at Six Flags. Always go into uncertain times, with a firm plan complete with contingencies.,,,,plan and stick to the plan.