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Recession Fears

Written By Brian Hicks

Posted January 18, 2008

It was August 1, 2007, when I made my “12,400 by November 1, 2007” prediction. I was two months off, but still spot on with the target.

Was I ridiculed by those saying the consumer is fine; that housing would turn around; that Dow 16,000 was a real possibility; that I was blowing recessionary and inflationary concerns out of proportion; that I had no idea what I was talking about. Sure.

But who’s laughing now?

The banks got it wrong. Bernanke, Paulson, Yun, Lereah, Bush, talking CNBC heads, banks, hedge funds, speculators, they all got it wrong.

My only question to them: How did you miss this looming disaster?

Knowing in early 2007 that $1 trillion worth of adjustable rate mortgages would reset between October 2007 and December 2008, I shorted sub-prime, housing, credit card companies, retailers, you name it. Sub-prime names were being sent to bankruptcy by the dozen. Delinquencies and foreclosures were picking up pace.

Yet the banks, the hedge funds and the market speculators ignored it. That was the reason I shorted the banks, too, shortly after Bear Stearns’ funds filed for bankruptcy protection and hefty multibillion-dollar funds began to unravel.

Here was my original argument for 12,400.

Dow 12,400 by November 1, 2007 . . . Mark These Words

Hefty multibillion-dollar funds are unraveling. Two Bear Stearns funds with heavy exposure to mortgage just filed for bankruptcy protection two weeks after telling investors that one of them was worthless and that the other lost 90% of value. Investment banks are tumbling. Foreclosures are up more than 50% year-to-date. Homebuilder confidence is low. Housing prices are coming down. Credit is deteriorating.

Oh, and there’s the S&P Case-Shiller housing index, which tells us that U.S. home prices just fell for the fifth consecutive month. That’s further proof that the housing market is not recovering. And then you have a market that doesn’t fully grasp the severity of sub-prime spillover into other areas of the economy. Until that happens, extreme volatility is the name of the game.

It’s only a matter of time before the bloated house of cards begins to come tumbling down. After watching the Dow plow right through 13,300 support, we’re bearishly optimistic of further Dow downside. In fact, if all goes as planned we could see at least 12,400 by November 1, 2007, on the heels of further housing, lending and credit decay.

Here’s why . . .

Says the New York Times, the peak month for mortgage resets happens this October 2007. That’s when $50 billion in mortgages will reset at higher rates. After that, says the report, about $30 billion worth of mortgages will reset every month until September 2008. When all is said and done, we could watch as $1 trillion worth of mortgages reset.

Imagine what’ll happen to cash-strapped homeowners with risky mortgages facing high resets. Some will do OK. Others will cut back on spending. Others, including an estimated 3.2 million homeowners, could face the risk of delinquency and foreclosure. That’s just one card pulled from the bottom of housing’s deck. The next one pulled could hurt even more when those foreclosed homes flood the market and depress housing prices even further.

You can argue that economic strengths outweigh housing weakness, but there’s too much uncertainty to bet on a big Dow recovery. Over the last ten years there has not been a housing bubble like this one. With so many mortgages about to reset, there are a lot of scared market participants heading into October 2007 resets.

While 12,400 has come and gone, I have a new prediction for you. As scary as it may sound, we’re headed sub-12K. A Fed fund rate cut will provide temporary relief, as will any economic stimulus package, which will supposedly take twelve months to be fully effective.

Mark these words . . . we’re headed sub-12K within the year on the Dow. And we’re likely headed lower on the NASDAQ as it breaks down after the right shoulder of a head-and-shoulders pattern.

Laugh if you will . . . but I had the last laugh with my 12,400 prediction.