Will 2008 be a lump of coal or a nice present for investors?

While in New York City recently I visited with several old brokerage friends. During that visit we all discussed the market and what may potentially be on the horizon.

One broker, whom I respect and consider quite sharp [even when I disagree], had an interesting comment on my predictions. I believe that the move to junk rating of ACA, the probable $6 - 12 billion loss at JP Morgan [significantly higher than expected], eventual losses from Citigroup – which reinsures itself, oil breaking $100 a barrel, and the multiple overseas investments will all hit the market in mid-January 2008. Thus I think a move to 11,000 is more than probable.

My friend disagrees. His view is that if I am correct in these outcomes, then the Fed will be forced to lower rates further immediately. He feels that this is the only way to stem the problem that is the mortgage crisis. This is especially true when you consider the increase in credit card debt.

“All the people with million dollar homes that would be refinancing and getting an extra $200,000… They find it hard to change their lifestyle quickly. That says nothing about most people who are feeling deflation. And add those paying the mortgage with their credit card and you have a market that needs the Fed to cut.” – Paraphrase

Sound reasoning. But I don’t think a bear market is avoidable.

The fact that the mortgage crisis is far closer to its beginning than end. I expect that there are far more homes in danger than has been seen to date. Even with the highly selective mortgage bailout stated by President Bush, many are going to be at risk. Credit card debt can only float for so long. With the added pressure of oil at or above $100 per barrel, which I expect mid-January as I stated above, more will fail even if rates are lowered (less than 2 points).

Add to this the fact that financials are at high risk. The early infusion of foreign capital may look good now, but this does nothing for future and continuing losses. It’s window dressing. With re-insurers like ACA in trouble and Japanese banks are unwilling to help bailout the shortfall (due to very limited exposure to this risk), the sector will be weak. Historically if financials are stagnant or falling so goes the majority of the market.

That says nothing of the potential of a Democrat becoming President. Again historically a negative pressure on the market. It is even graver with several prominent Democrats nearly promising to increase corporate taxes (or outright take their profits – especially oil companies).

The Fed can lower rates, but that will not stop the general malaise I see coming. At the least the first half of 2008 will not be good. A move to 11,000 seems inevitable. If I am correct then the question is this.

Will those experiencing deflation outweigh the inflation fears? And if more people lose their homes how much of our financial institutions are we willing to sell to avoid the harshest realities of a crash?