As can be seen in the St. Louis Federal Reserve chart below of the rate of change of household debt with shaded areas indicating a recession <http://research.stlouisfed.org/fred2/fredgraph?chart_type=line&s[1][id]=CMDEBT&s[1][transformation]=pca>, recessions are often preceded by a decline in the % change in credit growth.  Of the last 9 recessions, 8 of them have been preceded by a credit slowdown.  The exception was the 2002 recession.  The difference in the 2002 recession was that the consumer did not slowdown materially; the industrial sector fell off as the technology bubble burst.  We do not believe the US economy will be so fortunate this time as we are seeing a large downward change in credit growth.

Consumer Credit Crunch Part II

For now, most of the credit problems have been confined to the sub-prime mortgage area.  We believe the sub-prime mortgage problem will spread in 2008 to consumer mortgages, credit cards and auto loans.  This will be the next leg down in the financial sector as the consumer shows the strain of the high debt levels.  We do not think this is the time to buy the financial stocks.  We do however expect the financials to have some sharp rallies due to very large short sale positions in those stocks.  We think you will get better buying opportunities later in 2008 in the financial sector on the second wave of write downs in consumer loans.  Keep in mind that most write-offs so far have been in the sub-prime mortgage instruments that have been originally mispriced by Wall Street.  We would be a seller of investment bank debt and stocks as we expect more problems in the sector in 2008.  We expect some surprise bankruptcies in the financial sector during the year.   We will be watching for bargains in the financial sector later in 2008.

Stock Market

For 2008 cash or money markets will be king.  We expect the stock market correction to continue as the US economy slips into a recession.  We expect more problems in the brokerage sector with a possible failure or restructuring of a large investment bank due to derivative and liquidity problems.  We want to have cash to invest in what we expect will be some wonderful investment opportunities that will appear in 2008.  This year will be a stock picker’s market and you want to have the cash to pick up what we expect will be great stocks at bargain prices. 

Large Cap Multinationals

We expect the large cap multination sector to continue to do well in 2008.  This sector has been characterized by companies that are profiting from the growth that is occurring worldwide as China, India, Brazil and other major countries are developing a middle class.  This growth should continue in 2008 at a slower pace.  We expect China to slowdown led by a slower US consumer and over capacity in many areas of production.  The Chinese government has been trying to slow the economy for well over six months; these restrictions should also start to slow the economy soon. The large cap multination sector is also full of companies that have strong balance sheets with low debt levels.  Remembering that we are in a credit crunch, we would avoid stocks with high debt levels in general.  When credit is tougher to obtain, companies with high debt levels have to cut back expenses and projects and, as a result, are unable to grow.  Their borrowing costs also rise, which lead to further declines in earnings.  The other positive about the large cap stocks is that they tend to maintain better earnings growth in an economic slowdown.

Inflation

We believe that inflation will continue to spread throughout the economy in 2008.  Higher energy and food prices are only now starting to spread through the pricing structure.  These higher food and energy prices are being driven by worldwide demand from developing countries.  In addition we believe some countries are using their enormous foreign currency reserves to stockpile oil and grains.   This appears to be the start of more cost push inflation.  Inflation hedges should continue to do well unless the US falls into a severe recession.

Stagflation

When an economy slows down and inflation stays high it is known as stagflation.  Stagflation appears to be where we are headed.  We saw this problem in the 1970s and it was not a good time for stocks and bonds.  The people that did well were stock pickers, investors that could find growth in a slowing economy one stock at a time.  This is where Peter Lynch of the Fidelity Magellan Fund made his name.  So remember, there are always ways to make money in the investment markets.

The Dollar

The Dollar should continue to be weak against the Asian currencies such as the Japanese Yen and Chinese Yuan.  Much further declines against the European currencies will be more problematic as we have seen the dollar decline to a greater extent against these currencies.  The same could be said about the Canadian, Australian and New Zealand Dollars.  The question mark out there is will there be a crisis in confidence and a run on the dollar.

Dollar Tsunami???

If we continue to see the dollar decline precipitously into 2008 and bottom later in this year or the next, we could see a dollar Tsunami.  The Dollar Tsunami could occur if the dollar were to have a washout bottom accompanied by a large asset decline in the United States.  At that point in time investors around the world could rush in to take advantage of cheap stock and real estate values with their richly priced currency.  The Dollar Tsunami would mark a bottom in the stock market and a start of a sizable rally.  We will keep readers informed as the year unfolds.

Precious Metals Stocks

Stagflation is often good for gold and silver.  The stage is now set for gold and silver to have another move upward in this bull market.   We have a number of things working in the sector’s favor.  Inflation continues to rise as commodities move higher.  The Federal Reserve is cutting rates and loosening money supply to support the economy.  Remember, the bull market in gold began in late 2001 with gold at $275 an ounce when the Federal Reserve, concerned about “deflation”, flooded the system with money; they appear ready to repeat the process again because of the sub-prime credit problems.  Sovereign Wealth funds and foreign exchange reserve funds are loaded with dollars.  These funds are now scrambling to get out of dollars and will buy gold and silver.  Investors in developing markets tend to favor the metals and now have more income.  In 2007 we thought that silver would outperform gold, this was not the case as gold was up about 30% for 2007 and silver was up about 15%.  This should occur in 2008 with silver outperforming gold; either way, both metals and their respective stocks should continue to outperform.

Commodities

Commodities should have a substantial correction sometime in 2008 if the US slips into a recession as we expect.   The Baltic Dry Shipping Rates Index has recently shown their first decline since July of 2007 after going straight up for almost two years.  This is possibly the first sign of a slowdown in demand for raw commodities.  We believe a slowdown in the US will affect commodity demand out of China so this warrants attention.  We have to balance this off the effects of the commodity hoard that appears to be happening with some countries.   Oil should continue to do well after a pullback early in the year.

Fixed Income

Most fixed income bonds are priced off the yield to US Treasuries.  As an example, a 10-year corporate bond might yield 5.9% that is 200 basis points (5.90-2.00= 3.90) over a 10-year Treasury.  It is the same for mortgages, junk bonds and even muni bonds.  We believe the Treasury markets are artificially priced at too low of a yield as a result of a flight to quality by investors.  Also, the equity injections some groups have invested in to help the banks and brokers have come at a very high yield; in some cases 8-11%.  For these two reasons and the possibility of a recession we believe that the corporate bond markets will be priced lower going into 2008.  We would still stick to quality investments as the theme of the fixed income market in 2008.   Later in the year look to move down the quality curve in fixed income as value improves.  Texas municipal bonds are an excellent area for fixed income for high tax bracket investors.  In some cases they are yielding the same return as treasury bonds and are tax free.  The Texas economy should outperform other parts of the country and therefore, the muni bonds of Texas should do well.

Themes For 2008

Equity

Cash is King/ Money Markets

Large Cap Multinationals

Stable Demand (consumer staples)

Energy (value)

Gold & Silver

Lower US Dollar in Asia

Japan

Low Debt Companies

Stock Picker’s Market

Fixed Income

Quality Quality Quality

Government Bonds

Overseas Developed Markets Unhedged Bonds

Money Market

CDs

Less Than 10 Year Maturities

Texas Muni Bonds

Sectors to Avoid

REITs

Financials until mid 2008

Emerging Equity Markets

Utilities

High Yield Bonds

Emerging Market Bonds

Brokerage Firm Debt

High Debt/Poor Quality Balance Sheet Companies

China Funds

Remember Save Aggressively and Invest Conservatively!

Did you know that the MaxOut Savings Advisors money managers can now manage your IRA Rollover at Fidelity Investments?  At MaxOut Savings Advisors we use Fidelity Investments to handle our investments for our clients.  We invest in stocks, bonds and Fidelity and non-Fidelity no-load mutual funds. If you would like to sit down with Ted Geoca at MaxOut Savings Advisors and discuss your IRA Rollover or 401-k or just a retirement review give us a call at 713-627-0400 or email me at ted@maxoutsavings.com

Ted K Geoca

President

MaxOut Savings Advisors, LLC

Houston, Texas

ted@maxoutsavings.com                                 713-627-0400