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Market Outlook for the Early 2010s

Forecast of the Stock Market and Global Economy

Steven Kim

MintKit Research
www.mintkit.com

Disclaimer This survey is provided as a resource for information and education. The contents reflect personal views and should not be construed as recommendations to any investor in particular. Each investor has to conduct due diligence and design an agenda tailored to individual circumstances.

Keywords: Outlook, Forecast, Prediction, Stocks, Bonds, Financial, Markets, Currencies, Forex, Euro, Real Estate, Commodities, Debt, Economy, USA, Europe, Greece, China, India, Investing, Global, Strategy, Planning

2012 MintKit.com

Summary
A systematic approach to investing requires a prediction of the stock market and the global economy, whether the call happens to be a precise forecast or a rough guesstimate. As a backdrop for picturing the markets downrange, the main event of 2011 was the breakdown of the equity market along with the turmoil in neighboring fields such as commodities and currencies. One reason for the hullabaloo stemmed from the fitful progress of the economy in developed countries like the U.S., Britain and Japan. Another factor stemmed from the tizzy over the debt crisis in southern Europe, along with widespread fears of a breakup of the euro and collapse of the economy across the continent. These worries brought up the specter of a world plunging into a full-blown recession. Despite the current jitters in the marketplace, however, the global economy is slated to expand by more than 3% in 2012. Meanwhile the corresponding figure for the U.S. is about 2% even as Europe ekes out a paltry gain. On the financial front, the stock markets of the mature economies are likely to expand by roughly 16% before the year is out. Better yet, the bourses in the emerging countries should surge by 30% or so. On a different note, the smackdown of the stock market last year cropped up in sync with the long-range schedule of crashes. As a result, the sequence of blowouts appears to be on track in spite of the muddled breakdown rather than a clear-cut collapse after the bourse touched a peak in 2007. As things stand, the next crash of the stock market is likely to occur around 2017 in tune with the running tempo of bombshells since the previous century.

* * * According to received wisdom, the stock market is a forerunner of the economy at large. When the bourse flops, for instance, then the tripup is deemed to signal a setback in economic activity within half a year or so. On the whole, the popular image does make a fair amount of sense. As an example, a lot of investors try to buy or sell equities depending on the outlook for corporate earnings roughly half a year down the line. Moreover, the companies listed in the stock market represent a microcosm of the larger economy. In this environment, the bourse reflects the pulse of commerce along with the flow of profits. Regardless of the common perception, though, the stock market does a patchy job of predicting the tangible economy. All too often, the bourse merely reflects the jitters of the investing public in response to current conditions in the marketplace. The same is true of the other branches of the financial bazaar such as commodities or currencies. This survey examines the outlook for real and financial markets over the years to come. While the analysis deals mainly with the outlook for 2012, the review also considers the prospects further downstream.

Hits and Misses over the Past Year A year ago, we made a medley of forecasts for the global economy as well as financial markets over the medium range and beyond. For the long-range calls, only time will tell how the closely the auguries end up matching the reality. Even so, we can at this stage review the outcome for the shortish projections dealing with the year just past. Not surprisingly, the bodements were partly right and partly wrong. 4

For starters, the forecasts of the real economy turned out to be largely on target in spite of the weakness in the marketplace along with the hoopla in the financial forum. As an example, we had expected the U.S. economy to grow by a couple of percent over the course of the year; and the actual turnout was 1.7%. For the world as a whole, our prediction for 2011 was a growth rate of 4.5% or so (Kim, 2011a). That forecast turned out to be somewhat optimistic. According an estimate by the World Bank, the global economy grew by 3.2% over the course of the year (World, 2012). A glaring feature of the financial patch last year was the breakdown of the stock market. The crash of the bourse reflected rampant fears of an imminent recession in America coupled with similar concerns for Europe and the world as a whole. The benchmark of choice for professional investors namely, the S&P 500 index is made up of giant firms based in the U.S. Many of the companies obtain a hefty fraction of their profits from far-flung operations round the world. For this reason, the fortunes of the listed firms are tied closely to the vigor of the global economy. As we had expected a year ago, the U.S. economy expanded in concert with the world at large. Given the growth of economic output on the domestic front as well as global environment, the earnings of the companies in the S&P benchmark should have risen as well. In line with our expectations, the firms within the index did enjoy an upturn in profits over the course of the year. In fact, looking at the larger picture, the earnings of the companies have been rising steadily since the Great Recession of 2009. As a point of reference, consider the net income for the companies within the flagship index. At the beginning of 2009, the earnings per share came out to $13.08 on an annualized basis, after adjusting for inflation and presenting the amount in terms of constant dollars at the price level for November 2011.

A year onward, the corresponding value for earnings had soared to $56.68 per share. By the beginning of 2011, the profit level stood at $80.82 per unit. Moreover, the income level continued to rise as the year wore on. In fact, the earnings had hit rock bottom at $7.30 per share way back in March 2009. After that stage, the profit level climbed steadily from one month to the next, without a single reversal, until the autumn of 2011 and beyond (Multpl.com, 2012). As things turned out, March 2009 was also the point at which the S&P index bottomed out at the 666.79 level. When we keep in mind the previous paragraph as well, we note that the stock market turned around precisely when the earnings started to recover. In other words, the investing public was simply keeping up with the ongoing level of earnings for the companies within the benchmark. So much for the fanciful notion that the stock market always predicts the real economy ahead of time. Looking now in the forward direction, both the U.S. and the world as a whole are poised to trudge upward as the year wears on. In view of the decent earnings for the listed firms during 2011 as well as the healthy outlook for 2012, we would at this stage expect the bourse to be buoyant. Sadly, though, the market hovers pretty much where it had been a year ago. At this juncture, the outlook for the tangible economy is reflected in the likely course of corporate profits. According to one plausible estimate, the rising tide of earnings for the S&P companies is slated to slow down but not flip into reverse during the first half of 2012; after that, the profits should begin to speed up again in the latter half of the year (Yousuf, 2012). Given the sturdy turnout for the listed companies in the recent past as well as the cheery outlook for the near and midrange future, it would be natural for the stock market to be higher at this stage than it was a year ago. Yet, the sensible result has not come to pass. In other words, the investing public has of late been more irrational than usual. There are several reasons for the perverse behavior, as we will see later on. 6

A year ago, we were expecting the S&P index to rise by some 15% by the end of 2011. To set the baseline, we note that the yardstick had a closing value of 1,257.64 points at the end of 2010. Then the benchmark clambered to a peak of 1,370.58 by May last year. Based on the last two figures, the upswing came out to a rise of just 9.0%. Then the yardstick crumbled in stages during the summer and autumn before it began to regain its footing. The final value at the end of the year was 1,257.60. To put things simply, the market merely bounced around during 2011 and ended up where it had begun. By contrast, the Dow Jones Industrial Average rose by 5.5% over the course of the year. Meanwhile, the Nasdaq index slipped by 1.8% over the same period. In short, the real economy in the U.S. as well as the world at large behaved pretty much as we had envisioned a year ago. The same was true of the companies within the flagship index for the stock market. On the other hand, the investing public in its collective wisdom decided to leave the bourse pretty much unchanged over the course of 2011. In light of the improvement in corporate performance, the supine behavior of the equity market seemed to be more quirky than usual. No doubt the investers were unnerved by the bungling and hanky-panky of the politicians in the U.S. as well as Europe. These bogeys are examined in greater detail in the sections to follow.

Bombshells over the Past Year The year just past saw a parade of memorable events, ranging from the overthrow of dictatorships in Arab countries to the revolt of taxpayers in Western nations. From the standpoint of the worldly investor, the key developments included the bedlam over the bond market in Europe as well as a grass-roots campaign to rein in the public deficit in the U.S.

Debt Crisis in Europe The weakness of the economy in recent years served to expose another stumper that had been festering for a while in Europe. In the run-up to the financial flap of 2008, a gang of reckless banks in search of plump yields had bought up scads of bonds issued by the Greek government. The rash move was the handiwork of a clutch of big institutions located in France, and to a lesser extent Germany as well as other rich countries. After feasting on fizzy bonds for years on end, the time had now come for the gobblers to pay for the juicy returns they had slurped up in the interim. As is their custom, though, the wily bankers were not averse to calling on the taxpayer to come to their rescue. To save the bunglers from their self-inflicted wounds, the politicians of Europe saw fit to lend even more money to the bankrupt state that had issued the flaky goods. The pretext was that the bond market in Greece had to be propped up in order to save the stricken government. Otherwise a simple and cathartic act namely, an official default on the bonds would bring about the end of the world. The argument, such as it was, revolved around a series of amazing leaps of logic. Suppose that Greece were to acknowledge its spendthrift ways and admit the obvious: the mounds of money it had borrowed and squandered over the years was far too massive to ever pay back to any meaningful extent. If the government were to fess up to something that was obvious to any lucid investor, then Greece would be forced to leave the currency union. The latter move would then kick off the disintegration of the euro. The crackup of the common currency would be followed by the implosion of the networks of production in Europe, and thence the demolition of the global economy. Scary stuff, wouldnt you say? Or maybe not.

Sadly for the prophets of doom, the investing public found it hard to swallow the hogwash. Instead of calming the investing public, the bald attempts to fudge the truth and stick the taxpayers with the cost of the bailouts stirred up even more angst. The investors began to wonder what other varmints the pols were hiding in the closet. If the shamsters were so fond of twisting the facts about bogeys that were plain to see, what else were they plotting with wraiths that were hidden from view? And how much more havoc would the perpetrators seek to wreak upon the financial markets and the real economy? Amid the bluster and the muddle, the investing public on both sides of the Atlantic feared for the worst. As a result, the markets of the West wobbled and crumpled, and prompted the rest of the world to follow suit.

Cap on Debt in America On the other side of the pond, a groundswell of voters in America got upset over the growing injustice of the taxation system. A prime example lay in the spectacle of giant corporations shirking their duties when it came to shouldering their fair share of the tax burden. In this light a favorite exhibit of the gripers was a lender, Bank of America, which had received billions of dollars in concessions from the government even as the company earned sumptuous profits and paid nothing by way of income taxes. From a larger stance, the protesters reckoned that the government could rake in an additional bounty of $100 billion each year if the giant corporations were to pay their equitable share of taxes. The tidal wave of discontent gave rise to a grass-roots campaign in the U.S. known as the Tea Party. Before long, the voters in the movement managed to install a cranky gang of politicians to convey their message to the legislature. The upshot was a small but potent faction in Congress fiercely opposed to any increase in government debt. In fact, the objectors insisted on a cutdown of the budget deficit over the years to come.

So headstrong were the naysayers in Congress that they brought the budgeting process to a grinding halt. As a result, the federal government almost ran out of money as the summer wore on. Thanks to the antics of the politicians along with the gridlock in Congress, the risk level for government debt was ratcheted upward by a rating agency for the first time in U.S. history. The hard cap on public debt was bound to have malign as well as benign effects. On the upside, the clampdown constrains the ability of the government to waste oodles of money on programs that are not only feckless but harmful to the nation as a whole. Thanks to the cutdown of waste in the public sector, the purchasing power of the dollar will shrivel more slowly in the future in comparison to the steep decline in recent memory. As a result, the greenback is slated to survive a couple of decades longer than it would have done otherwise, before it finally becomes worthless and turns into a historical relic. On the downside, though, the choke on public spending hampers the ability of the government to pursue not just noxious programs but hearty ones as well. In view of the frail health of the economy at this stage, the politicians ought to be taking direct action to shore up the chains of production in a wholesome fashion. Given this backdrop, the timing of the clamp on debt was execrable. It would have been far better for such a cuff to be slapped on when the economy happened to be perky and robust. From a realistic stance, though, the voting public would not feel the urge to express their displeasure during a period in which jobs were plentiful and wages ample. For this reason, a prudent act such as a curb on public debt could only arise in a woeful setting such as the current environment. Owing to the cap on debt, the government now finds itself in even worse shape than before. For this reason, the economy is doomed to stagger and struggle for many more years to come.

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To sum up, a big surprise this year took the form of a stiff choke on government debt in the United States. The curb on the public deficit led to a paralysis of decision making over the national budget. Thanks to the stalemate in the legislature, the government almost ran out of money to pay its bills. The close call in turn prompted a rating agency to downgrade Treasury bonds for the first time in history. Thanks to the clampdown on debt, the government found itself in a straitjacket. In the runup to the elections of 2012, the politicians would normally go on a spending spree in order to pump up the economy. In the current environment, though, the usual antics would have to be shelved due to the cuff on the federal deficit. Without a big boost to the economy fueled by a binge of government spending, investors saw no reason to lift up the bourse in 2011. The dearth of animal spirits in the marketplace was of course an abnormal turnout for a pre-election year. The ruckus in the legislature played a big role in whomping the the stock market and keeping it down.

Assault on Wall Street In the throes of the Great Recession, the U.S. and many other countries decided to shore up the housing market along with the financial sector. By propping up the rickety assets in real estate, the politicos were in effect going out of their way to uphold the distortions in the economy that had cropped up during the run-up to the financial crisis. As an example, the ill-formed moves included direct schemes to buttress prices in the housing sector, as showcased by a program of public guarantees for private loans. To add to the mischief, the indirect plots included crutches for crippled banks that had gone overboard during the housing craze and now continued to hold onto a multitude of distressed properties.

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Over the past couple of years, the price of real estate has of course climbed down from the ditzy heights scaled during the heyday of the housing craze. Even so, the puffy prices are still out of whack compared to the current level of wages throughout the population. The financial flap, along with the Great Recession, had thrown millions of people out of work and squelched trillions of dollars of household wealth in every major country round the world (Kim, 2012). In that case, the natural level for the housing market at this point would be even lower than the beefy prices prior to the onset of the housing bubble. On the other hand, the heap of crutches meant to buttress the bloated properties and zombie banks ended up thwarting the natural process of adjustment and recovery throughout the economy. As is often the case in a financial flap, the knee-jerk reaction of the demagogues served to exacerbate the problem and prolong the torment rather than cure the illness. Unfortunately, the voices of reform in the public sector have been too few and feeble to address the challenges in a serious way. A batch of bitter pills would be required in order to heal the financial forum as well as the real economy in earnest. The healthy tack is to scuttle the artificial shackles in the marketplace. The economy would then suffer a short and sharp recession, followed by a fresh start and a sturdy recovery. As a group, though, the putative leaders were unable to muster the grit needed to take the high ground. In the absence of true leadership, the developed nations of the world will continue to stagger and struggle for many years to come. The quandary resembles the plight of Japan during the lost generation that began in the early 1990s and continues to this day. The lack of mettle to revamp the system wholesale has condemned the nations of the West to a similar fate over the decades to come. On the other hand, it doesnt have to be this way. Luckily for the Western countries stuck in the muck, a large swath of the population is unwilling to take the flimflam lying down. A plain example is found in the grass-roots 12

campaign known as Occupy Wall Street, a movement which came to life in New York and spread like wildfire to hundreds of towns in the U.S. and thousands more on foreign shores. Going forward, the vital task of the firebrands in the popular campaign is to converge on a concrete set of measures for public policy. If the activists should succeed in pushing through a workable agenda, then the U.S. and other supple nations can look forward to a brand-new era of reform and renewal, of innovation and upgrowth.

Fitful Progress of the Economy A widespread cause of concern last year lay in the spasmodic progress of the real economy throughout the developed regions. The anxiety was compounded by the misguided moves of public officials in recent years in response to the financial crisis, Great Recession, and knock-on debacles. On one hand, the politicos did manage to stauch the gush of panic in the marketplace by making reassuring noises about taking decisive action to counter the problems. On the other hand, the flurry of measures drummed up to date have served to strangle and suppress the economy rather than nurse it back to health. Another source of angst lay in the state of public finances in southern Europe. The debt monster, which had been incubating for years on end, was thrust into the floodlight by the breakdown of sovereign bonds in Greece coupled with the empty coffers of the national treasury. As is often the case, the politicians of the European Union managed to turn a hillock into a mountain by whipping up a rash of counterproductive schemes. The upshot of the folly was to throttle the economy and prolong the agony rather than cure the ailment. The crux of the problem sprang from a rampant misconception about the true nature of the malaise. The mixup hampered myriads of actors including frazzled investors and frantic politicians. 13

An exemplar lay in the cause of the debt crisis along with the impact of clumsy responses. According to one flight of fancy, a default on bonds by the Greek government would spark a chain reaction of epic proportions. The crackup would lead to the breakup of the unified currency in Europe, followed by the smashup of the meshwork of production and distribution throughout the continent. The regional fiasco would in turn knock down the global economy. Ergo, the bond market in Greece had to be propped up at all costs in order to save the euro as well as the regional economy, not to mention the health, wealth and happiness of all mankind. On one hand, any thoughtful person would agree that the breakdown of the bond market in one small country could perhaps set off a chain reaction that leads to the destruction of the world. But the same is true of any event anywhere in the world. The stickler is no different from the universal ferment of chaos that governs the course of natural events as well as human affairs. A plain example involves the buzz of a wasp in Africa whose flapping sparks a gale that alters the trade winds and brings on a new ice age. The real question for a live mind is not what could happen, but what is likely to occur and how big the impact would be. With this mindset, the prudent person takes steps to improve the prospects of a cheery outcome in favor of a grody turnout. Where the hoopla over the debt market is concerned, a frail economy thats tied up in knots is far more likely to crumple wholesale than a nimble one that has the wherewithal to adapt more freely in response to sideswipes. But shackling the economy is precisely what the politicians have been doing since the onset of the financial crisis in 2008 along with the aftershocks such as the debt flap in Europe.

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Right Way Forward In order to tackle the problems in a serious way, the first step is to remove the fetters that hamper the markets. The next task is to stop molesting the economy and instead give it the leeway it needs to recover on its own. There is of course, a third and optional move. The hearty tack is to take concrete steps to bolster the process of creative destruction along with the swift recovery of the economy at large. In this light, a good example of a healthy move is to clear the slate by pulling the plug on brain-dead firms that are unable to earn an honest living. To save a bunch of battered banks from their self-caused wounds is to fritter away the taxpayers money and to prolong the distortions in the real economy. A second instance of a wholesome course lies in a policy of matching grants for training the unemployed, including any laid-off workers from the newly defunct banks. The subsidies could help the jobless in learning fresh skills in order to participate in the economy in constructive rather than destructive ways. A third sample is a program of partial guarantees offered to financiers in the private sector. As an example, the government could expand its support for investment companies that work in concert with the Small Business Administration. The program would expand the pool of capital available for use as loans to newborn entrepreneurs and their fledgling ventures.

Picture of Economic Growth On the upside, the outlook for world growth over the next few years is more sunny than it has been in the recent past. The upbeat tone is reflected in a forecast by the Organisation for Economic Co-operation and Development (OECD), a club of several dozen rich countries dotted round the planet. 15

In the U.S., the gross domestic product is expected to grow by 2.0% in 2012, followed next year by an increase of 2.8%. By contrast, the 15 countries of Europe that employ the common currency is slated to eke out only 0.2% this year, followed by 1.4% in 2013. From a larger stance, the entire membership of the OECD is set to expand by 1.6% in 2012, then 2.3% the following year (Organisation, 2012). In this way, the mature economies will continue to clamber upward despite the specter of gloom and doom hanging in the air. In a similar way, we can expect the emerging markets to grow at a moderate pace this year before trotting ahead in 2013. A plausible forecast for the world economy as a whole is a growth rate of 3.2% in 2012, followed by a small increase of 3.5 percent each year on average from 2013 to 2016 (Conference, 2011).

Backdrop for the Next Crash of the Stock Market After the bust of the Internet craze in 2000, the stock market in the U.S. tumbled in fits and starts for a couple of years. After that stage, the bourse regained its footing and trudged to a summit in October 2007 before running out of steam once more. After reaching the zenith, the equity market did not break down all at once. The same was true of the housing sector in the U.S., which had crested the previous year. On one hand, the property market had begun to falter by 2006. In April that year, the median price of new homes in the States touched a peak then began to flounder and slide (Census, 2012). On the other hand, the hullabaloo was still in full swing in many other locales ranging from Europe and North Africa to Asia and South America. In Britain, for instance, the housing craze lasted until the first quarter of 2008 (Nationwide, 2011).

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During the upswell of the housing bubble, legions of punters had bought up gobs of financial assets built atop risky mortgages. The binge of betting on dicey rigs was led by an army of wildcats in the form of hedge funds. The gamesters of this stripe included boutique outfits standing on their own as well as cloistered groups lodged within larger concerns such as commercial banks. Due to the complexity of the new-fangled assets in the financial ring, nobody could grasp the full extent of the hazards entailed by the gizmos. To make matters worse, the eager beavers took up humongous amounts of leverage, up to a hundred times or more of the value of the stake put up at the outset to serve as collateral for the wagers. The lofty levels of gearing ensured that the principal would be wiped out at once when the house of cards came tumbling down, as it was bound to do sooner or later (Kim, 2012). As the frenzy in real estate began to fizzle out after 2006, the windfall bagged by the speculators was fated to do likewise. Worse yet, the spree of profits scooped up on the upswing would duly turn into a spew of losses on the downstroke. The breakdown of mortgage-based assets turned into a full-fledged rout in 2008, giving birth to the biggest bombshell in the stock market since the early part of the previous century. Moreover, the blowup of the bourse was soon followed by the worst recession in the global economy since the Second World War. Thanks to these superlatives, the crackup of 2008 was a shocker to remember.

Hazy Horizon The pandemonium in the marketplace brought on a heap of uncertainty over the prospects for the years to come. To begin with, the housing frenzy and its aftershock had knocked out the banking system and bashed in the real economy. For a second thing, the blubber in the housing sector and the credit market had disrupted the price signals in the marketplace. As a result, the chains of production and distribution were bent grossly out of shape. 17

So severe was the mangling that the warpage was unlikely to unwind in earnest anytime soon. In that case, the economy would have to limp along for many years to come even after it managed to crawl out of an outright recession. To add to the distress, there was worse news still. In their great wisdom, the fearless leaders decided to pander to the lobbyists from the banking industry. In America, Europe and elsewhere, the politicans gave birth to a litter of deformed schemes to prop up the largest banks and save the pulped outfits from their self-inflicted wounds. For this purpose, the first act of the politicos was to scrounge up trillions of dollars in order to bail out the shattered banks. A second, and related, move was to take active measures to shore up the housing market. The refusal to let the comatose banks die a natural death came to impose a whopping burden on the society at large. By propping up the bettors in the banking industry and the housing sector, each government consigned the local economy to a slow and tortured recovery. The financial flap and the Great Recession in its wake had nuked millions of jobs and nixed trillions of dollars of wealth in each of the major countries of the world. Thanks to the brilliant schemes designed to sustain the rot, the population as a whole faced a future chockfull of hardship and frustration. The flogging suffered by the body politic was spotlighted by the upsurge of unemployment as well as poverty. As an example, the jobless rate in the U.S. soared from 4.4% in May 2007 to 10.1% by October 2009. On a positive note, the recession came to end by the summer of 2009. Even so, the plight of the labor force hardly improved for years to come. For instance, the unemployment rate was still hovering at 9.0% in October 2011 (Labor, 2011). The devastation was worse in terms of the millions of souls thrown into abject poverty. According to official figures, 15.1% of the U.S. population was living in poverty in 2010. 18

The proportion, which had risen from 14.3% the previous year, was the third consecutive rise in the annual survey (Census, 2011). In the meantime, the economy was saddled by a load of bloated banks that had scant interest in playing its proper role in the marketplace. In delving into this issue, we should keep in mind that the core function of a commercial bank is to take in cash from thrifty folks and lend out the money to creditworthy parties. In the world of commerce, certain actors need to borrow cash as a matter of course while others dont. To begin with a counterexample, large companies as a group drum up enough profits from their operations to finance their ongoing activities as well as newborn ventures. Moreover, a big and established firm has the wherewithal to obtain capital directly from the investing public by issuing stocks or selling bonds. For these reasons, a giant concern rarely has any need to borrow money directly from a bank. By contrast, small and midsize firms are often obliged to set up lines of credit in order to finance routine operations as well as fund projects for expansion. A case in point is the moola required to obtain a letter of credit whose function is to back up a purchase from a foreign supplier. Despite their mission, though, the banks that had received bailouts from the government had little or no interest in fulfilling their only real function in the economy. Instead, the banksters found other uses for the moola much better to their liking. A fine example involved the shunting of billions of dollars by a single firm in order to pay princely bonuses to favored employees. Another common ploy of the hustlers was to buy up weaker rivals, thereby reducing the scope of competition within the banking industry. As for the rest of the dough, the banksters chose to hoard the money wrangled out of the public treasury. To top it off, the cash infusion from the government enabled the recipients to hold onto huge stockpiles of properties rather than sell them off in order to whittle down their 19

holdings and pay off their bills. If the housing market had been left alone to do its job, the average price of homes would have quickly subsided to a sane level following the loony buildup of prices during the property craze. On the other hand, the tight grip on properties held by the banks acted as an artificial plug that stymied the housing sector and kept the market from losing its froth. As a result, the property sector could not cast off the flab as a prelude to regaining its health. Due to the contrived chokes on pricing, myriads of homes stood empty for want of buyers. At the same time, millions of souls lived in squalor because they couldnt afford to buy or rent decent homes for their families. Given the mass of artificial props, the housing sector continued to be overpriced in relation to the average level of income. In this and other ways, the property market was prevented by the government from regaining its vigor. At first blush, the ham-handed program of support for the housing sector might seem like a blessing for the folks who already owned their homes. While the rigidity in the marketplace might seem beneficial over the near term, the impact over the longer range was the direct opposite. The reason stems from the fact that the housing market can only flounder in the midst of an ailing economy. By contrast, the cost of living for the population as a whole continues to climb higher in the modern era. The main driver behind the advance lies in the groundswell of demand for natural resources from the emerging nations. For this reason, the price of food, fuel and other commodities in the global marketplace is destined to increase in spite of the occasional breathers from time to time. In that case, the goblin of inflation runs riot even if the local economy ends up going nowhere at all. What happens if the price of a property remains fixed in nominal terms in an epoch in which the cost of living rises by a handful of percent each year on average? The real value of the dwelling of course shrivels up due to the relentless press of inflation. 20

Looking at the larger picture, the property sector is a pillar of the economy at large. Given the shackles on real estate, however, the housing market has turned out to be a brake rather than an engine of growth. The crummy outcome is no picnic for the beleaguered owners of homes nor anyone in the economy at large.

Patterns in the Stock Market The past is a lousy guide to the future. Even so, its the main source of insight available to anybody. One way for us to presage the market downstream is to begin by reviewing its behavior over the past few years. In this light, the big landmark was the financial fiasco of autumn 2008 after which the S&P 500 index crumpled in stages to a low of 666.79 the following March.

Trading Volume as a Key to Human Behavior The tenor of the market can be grasped at once on a bar chart that portrays the price level, including the high and low values within each time slot. The following exhibit, from Yahoo Finance, depicts the romp of the S&P index over the span of five years ending in early 2012. The lower pane in the diagram shows the volume of trading for the stocks covered by the index. Starting from the bottom left of the chart, we can see that the turnover increased gradually, despite the inevitable variations over the short run, until the second half of 2008. The market reached a climax as the financial crisis flared up that autumn. Amid the panic in the market, the volume of transactions for the S&P benchmark hit a peak of 11.5 billion shares on October 10 that year.

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To a lesser extent, a horde of investors rushed into the arena once more during the bout of selling that marked the bottom of the market in March 2009. Following that debacle, another blitz of sales swept though the bourse during the smashup of spring 2010. By contrast, the blowup of the market in autumn 2011 was attended by a smaller binge of selling. In view of the reduced volume, we can infer that the meltdown last fall stemmed from the withdrawal of buyers from the bourse rather than an onrush of sellers. Put another way, the blowout in the arena was not as hysterical as it had been in the previous couple of flops despite the awesome depth of the latest plunge.

Rocky Path of the Bourse We now shift our focus from the volume of trading to the value of the benchmark. In April 2010, the S&P index touched a peak of 1,219.80 points. Then the yardstick fell to a low of 1,010.91 units three months later. From the peak to trough over this stretch, the market had crashed by a little over 17%. 22

Then the flagship index tramped upward once more, reaching a high of 1,370.58 in May 2011. The next move was a plunge within three months to the 1,074.77 level. The knockdown turned out to be another whopper amounting to a cut of nearly 22%. From the low plumbed in 2010 to the peak reached the next year, the market rose by almost 36%. Given the severity of the crash in 2011, we would expect a rebound of similar magnitude on the subsequent stretch. Starting from last yearss low, a rise of 36% corresponds roughly to the 1462 level in absolute terms. Another point of reference is the value of the benchmark at the end of last year, which came out to 1,257.60 points. When we compare the last two figures, the peak represents an upswell 16.3% from the terminal value at the end of 2011. In other words, the market is apt to rise by 16% or so by the end of this year. As we noted earlier, the top of the ascent corresponds to the 1462 level. Given this backdrop, the sage investor would do well to trim the sails and take up a defensive pose as the benchmark nears the target zone. As usual, though, we can expect a goodly amount of turbulence to the downside as well as upside as the months go by.

Impact of the Election Cycle In the absence of big surprises, we can expect the financial markets to play out pretty much as they have done over the past couple of years; namely, trudging higher in fits and starts. The same is true of the real economy. As an example, the volume of economic output for the world as a whole is slated to rise by a little over 3% during 2012. In line with earlier remarks, the U.S. economy is apt to expand by a couple of percent in the year to come. On the other hand, Europe will continue to suffer from the slings and arrows of misfortune as the politicians dither and conspire in the midst of the debt crisis. Instead of taking 23

decisive steps to heal the markets for good, the vote mongers have opted as usual to take the facile route of propping up the rot and stretching out the misery. For this reason, the Old World is likely to turn in a piffling gain of about 0.2% this year. Thanks to the follies of the leadership, the jitters among investors and businessfolk alike continue to buffet the economy. After a labored advance during the first half of 2012, however, the economy should gain more traction in the second half. Given this outlook for the real economy, the proper response of the U.S. market is to rally rather than slump. Another motive force comes from the election cycle in America. A year in which a Presidential election takes place tends to be a buoyant spell for the U.S. bourse. The lift to the stock market is showcased by the performance of the Dow Jones Industrial Average. The exhibit below, courtesy of Seasonal Charts, shows that the benchmark is prone to rise by more than 7% on average during an election year such as 2012. In that case, the stock market is poised to advance more strongly than usual this year. Yet another factor lies in the cruddy turnout of the stock market during 2011. Certainly there was plenty of cause for investors to stomp on the European markets last year. But there was no good reason for beating up the U.S. bourse as well. It seems likely that the financial community will see the error of their ways as the months go by. In that case, the U.S. bourse should make up for its drab performance from 2011. Given this backdrop, we expect the stock market to push higher during 2012. As we saw in the previous section, a credible projection is a rise of 16% or so for the S&P index by the end of the year. As usual, the forecast could fall apart for any number of reasons. An obvious example involves a spat in the Middle East over the prospect of Iran building a nuclear arsenal with which to bully its neighbors.

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In the absence of big surprises, though, we can expect the default forecasts to play out as envisaged. In that case, 2012 looks set to be a buoyant spell after a disappointing stretch. Whatever the turnout this year, the next few years are apt to be more of a mixed bag. On a positive note, the European economy is likely to stage a frail comeback in 2013. Thanks in part to the upturn on the continent, the global economy should be a tad more sprightly next year than it is today. By contrast, the U.S. has scant reason to expand at a peppy pace in the years to come. In that case, the economy is set to advance by only a couple of percent a year in line with the norm in the modern era.

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On the downside, though, the stock market is likely to fare worse shortly thereafter. The next couple of years correspond to the weakest stretches of the election cycle in the U.S. For this reason, the stock market is slated to turn in an anemic performance in 2013 as well as the year to follow. In that case, the bourses of the emerging countries should expand at a breezy pace during 2012, followed by a slowdown for a couple of years afterwards.

Forecasting the Next Crash On average, the stock market in the U.S. has a habit of crashing a couple of times a decade. A recent milestone lay in the ascent of the S&P index to an all-time high of 1,576.09 in October 2007, followed by a stepwise collapse over the span of a year and a half. On the heels of the financial flap and the Great Recession, an interesting question for the mindful investor was the timing of the next debacle. From the standpoint of 2009, the global economy was slated to flounder and stagger well into the 2010s thanks in large measure to the counterproductive schemes of public officials. Meanwhile, the financial forum would also continue to wallow in the doldrums. For these reasons, there was scarcely any room for a bubble of any sort to crop up in the marketplace. Given this background, it was unclear to us during the recession of 2009 just when the next bombshell would pop up in the stock market. According to the long-range timeline, the bourse was destined to break down in 2011. On the other hand, neither the real economy nor the financial bazaar would have recovered sufficiently within a couple of years to justify a full-scale blowout. Rather, an additional stretch of a few years would be required for the bourse to claw back a hefty fraction of the losses suffered during the financial flap. After recouping a goodly amount, the market would then be ready for another sideswipe and knockdown.

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Despite our reservations, though, the subsequent crash of the stock market showed up right on time according to the long-range schedule. In 2011, the feeble state of the economy in the mature nations weighed heavily on the sentiments of the financial crowd. As the shabby numbers on jobless rates and economic growth trickled out of government agencies, the punters in the forum were seized by fears of a fresh lapse into a full-blown recession. In this edgy climate, the U.S. bourse rose to an apex in the summer of 2011, then broke down shortly afterward. As a barometer of the stock market, the S&P 500 index touched a high of 1,370.58 points in May. Then the benchmark thrashed around for a couple of months before plunging to 1,074.77 by October. From peak to trough, the index had flopped by a thumping 21.6%. As usual, though, the stock market was shoved into the abyss by the madding crowd for no good reason at all. To wit, a crippled economy is not the same thing as a prostrate one. In line with earlier remarks, the chains of production and distribution had been twisted grossly out of shape by the monstrous bubble of the housing market and mortgage-based securities. Given the scale of deformation, the economy could only flail around and crawl along in fits and starts. To compound the problem, the politicians had chosen to prolong the agony by propping up a heap of dysfunctional banks and overpriced properties. The nutty moves of the government served to foul up the natural process of recovery throughout the marketplace. In this sickly environment, the economy was doomed to gnash and grind far longer that otherwise. Despite the welter of abuses, though, there was no reason why the meshwork of production and distribution should fall apart all of a sudden. Even so, the lack of cause was not enough to keep the stock market from taking a nosedive. In any event, the first crash of the 2010s showed up right on time according to the long-range timetable. 27

As a result, it appears that the sequence of blowups is back on track (Kim, 2011b). In that case, the next bombshell is likely to pop up around 2017. Until then, the default forecast for the next few years calls for a spell of relative calm in the equity market.

Summary of Forecasts The global economy is slated to expand by some 3.2% over the course of 2012. By way of comparison, the corresponding figure for the U.S. is 2.0% while that for Europe is 0.2%. Meanwhile the rich countries as a whole are set to grow by 1.6% as the year wears on. By contrast, the front-runners in the emerging regions will continue to power ahead at a heady clip. In jaunty countries such as China and India, the pace of growth should hover around 7% or more per year. As in previous years, the exporters to the budding nations will fare somewhere in between the two extremes of growth. A case in point is Australia or Canada in their role as exporters of raw materials to the sprouting regions. Another sample is Germany or Korea as suppliers of capital equipment or finished goods. Meanwhile, the debt flap in Europe will continue to frazzle nerves, dampen moods, and subdue trade in 2012. In this fretful environment, a reasonable estimate for the year is an upturn in global output by a few percent as we discussed earlier. On a cheery note, an election year such as 2012 tends to be a tonic for the U.S. bourse: the government likes to put on a good show of trying to rev up the economy. For this and other reasons, the stock market is likely to swell by 16% or so as the year wears on. Since the American bourse acts as a bellwether for the rest of the world, the upswing will help to lift the stock markets in remote countries as well. In that case, a representative index of emerging markets should expand by roughly 30% before the year is out.

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In the absence of any big surprises, the markets of the world are slated to press ahead in 2012 along the lines described above. Moreover, the outlook for the equity market in the years to follow is a tad less sparkling but still cheery even so. Another benign streak lies in the habit of the U.S. bourse to space out bombshells at intervals of a few years. As things turned out, the smashup of the stock market last year cropped up in tune with the long-range schedule of crashes. Given this backdrop, the sequence of blowouts appears to have regained its usual tempo in spite of the muddled performance before, during and after the financial crisis of 2008. As things stand, the next crash of the bourse is likely to occur around 2017 in sync with the long-standing rhythm of flops since at least the autumn of the 20th century. On one hand, any forecast of the marketplace can go awry due to sideswipes ranging from monstrous earthquakes to terrorist acts. Even so, the most plausible prediction at this stage is a spell of relative calm for the stock market, in comparison to the past few years, as the global economy trundles along at a modest pace.

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Organisation for Economic Co-operation and Development. Economic Outlook No 90 December 2011 - OECD Annual Projections. http://stats.oecd.org/Index.aspx? DataSetCode=EO90_INTERNET tapped 2012/1/8. World Bank. Regional Detailed Forecasts. http://web.worldbank.org/WBSITE/EXTERNAL/EXTDEC/EXTDECPROSPECTS/EXTGBL PROSPECTSAPRIL/0,,contentMDK:20381640~menuPK:659183~pagePK:2470434~piPK: 4977459~theSitePK:659149,00.html tapped 2012/1/9. Yousuf, H. Earnings Outlook: Bye-Bye, Double-Digit Growth. 2012/1/9. http://money.cnn.com/2012/01/09/markets/earnings_outlook_fourth_quarter tapped 2012/1/9. * * *

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