The Great Crisis of 2008

In these turbulent times, it’s hard to grasp how serious our current economic situation truly is. The news media, desperate for a story that will capture an audience, are claiming that we are on the verge of financial Armageddon. On the other hand, you can find financial pundits who claim that we are merely experiencing a “hiccup” and that the economy will recover rather quickly. So who should you believe?

I was fortunate enough this week to have the opportunity to hear one of Wall Street’s leading economist’s speak very candidly about the current state of the economy. Leading economists have a reputation of rarely go out on a limb, but simply presenting the facts as they see them. That made this economist’s comments even more sobering as he very bluntly stated that we are facing the “greatest crisis since the Great Depression”.

Consumers Face Perfect Storm

American consumers have spent freely over the past few years, completely unconcerned that their expenses exceeded their incomes. This seemed irrelevant for many, as their escalating home values and readily-available credit lines provided additional sources of cash. Now we are slowing facing the ugly reality of our shameless living.

Home values are now falling at the same time that oil prices and basic commodity prices are rising. Unemployment, which has not been a concern for many years, is expected to spike in coming months. Consumers are going to be forced to cut back their spending to realign with their income levels. Over the next decade, economic growth could be hampered by reduced consumer spending.

It’s been surprising to some that the American economy has remained so resilient in the face of disaster. However, that is expected to change very soon, as the one component of GDP that has kept us from a recession – exports, is falling fast. The recession is spreading to Western Europe which will lessen their demand for American goods. Even in China, where government subsidies have insulated their booming economy from the effects of rising oil prices, are suddenly finding those subsidies reduced.

Most Serious Crisis Since Depression

Back in August - September 2007, there was concern that we could potentially be facing the “most serious crisis since the Depression”. By March of this year, many leading economists are very confident that this is the case.

Just like with the Great Depression, this recovery will need to be calibrated not in months, but in years. It could take another decade for the markets to fully readjust. At the very least, we are looking at 2-3 years of dislocation in the markets.

Investors should not be looking for a recovery in the housing market in the near term either. We are only in the third year of a housing downturn, following an unprecedented run of 14 consecutive years of price appreciation. Housing cycles are notoriously lengthy – lasting an average of eight years. Playing the law of averages, we should not expect a housing recovery until 2013.

Oil Price To Continue Rising

One bright spot for investors (although not for consumers) is that ovver the long-term, oil prices are going to continue to rise. The world is heavily dependent upon oil and there is only a limited supply. In the next 12 months, oil prices will probably trade in the $80-150 range.

Of course these escalating oil prices are leading to another phenomenon – the transfer of wealth. America, along with much of the developed world, is transferring its wealth to the Middle East in exchange for black gold. Individuals and entire nations are becoming tremendously wealthy due to the rising oil prices. Even Russia has emerged once again as a super-power due almost entirely to the fact that oil now trades above $100 a barrel.

Proceed With Caution

For the individual investor, caution remains the watchword. It’s not out of the realm of possibility for US equities to post negative returns over the next ten years. This trend will only be accentuated by the withdrawal of baby boomer wealth from the financial markets.