The Challenges Continue

The first half of the year was obviously not a good one for the financial markets, and my prediction is that the second half is not going to be much better.  There is simply just way too much uncertainty around a large number of factors.  Here is a short list:

-      -- The impact of  the huge rise in commodity prices globally – i.e. inflation.  I have read a number of articles recently that challenge how we measure inflation and most of the thoughtful ones seem to indicate that such measures are way underestimating it.  My personal experience would have to agree.  A quick example.  We spent the summers in Kelowna BC Canada where my family runs an orchard producing approximately 500,000 pounds of fruit a year.  My father came in the other day fuming because the price of a bottle of chemicals he needs to spray the fruit went up from $600 last year to $1,000 this year.  A bag of fertilizer, $35 last year, $60 this year.  Even if oil settles down just north of $100, the impact is just beginning to work it’s way past the fuel pumps and in to the system. 

-        - The financial chaos.  More banks and other financial institutions will go under and the effect of that is hard to measure but it will be costly.  Moreover the write-offs will continue as delinquencies are still relatively low and on the rise.  Look at Wachovia’s reported earnings as a hint.  Fannie Mae and Freddie Mac? Personally I don’t do naked short selling but if I were too anyone who has spoken to me on this topic would know that there two stocks have been on the top of that list for years.  Their business model went awry a long time ago right under EVERYONE’s noses.  A publically traded company, which invests in mortgages to the advantage of everyone else because they were implicitly backed by the triple A rating of the US gov’t?  People responsible will, years from now, or maybe tomorrow, be asking themselves, what the heck were we thinking?  IndyMac, Countrywide  blah blah…. All business models that evolved in to banking on the stupidity of others and the idea that the party would never end, but if it did, the people again responsible would be long gone or somehow would have figured out a way to reverse the trade. 

-        - The housing collapse.  Again not over.  There is still a lot of adjustment that has to take place and all this takes time.  Foreclosures are on the rise which will continue to cause massive dislocation.

-        - Global growth.  Just a lot of uncertainty and huge differences across countries.

-        - Geopolitical risk.  I am going to ask  my husband to do a guest blog on this topic. 

-        - Election year in the US and more generally a big risk that a lot of not well thought out regulatory changes happen in response to all the problems that are out there.

This list is not exhaustive of course, and each bullet point is in itself extremely dense.  The point is again is that there is a lot of uncertainly which creates a whole lot of possible outcomes.  From an investment perspective that means much higher risk, and for that, investors should demand a lot of extra return.