10 market predictions for a glum '08

By Jon Markman

For investors, the new year will be defined by a titanic struggle between governments' efforts to flood the world's faltering financial system with cash and banks' efforts to hoard it all for themselves.

Commercial banks are stashing instead of using the cash infusions because leveraged mortgage bets gone bad are shrinking their capital bases faster than central banks and foreign investors can refill them.

• Top Stocks blog: Check out how Markman's '07 predictions panned out

So what are the prospects for investors in this unhealthy environment? Here are the surprises that I see lying ahead:

1. Bank bankruptcy

Every financial crisis of the past 200 years has resulted in the bankruptcy, merging and closing of many banks. Sometimes even very large ones. This crisis will be no exception. Bankruptcy is an efficient means of clearing deadwood out of the forest, where it is purposelessly hogging resources, so that newer, stronger competitors can thrive.

Expect at least one major bank to fail in 2008 as high-risk mortgage and business loans made in the mid-2000s by more than 2,500 U.S. financial institutions lead to lethal losses. Citibank (C, news, msgs), which may already be technically insolvent, is probably too large to be allowed to fail.

But smaller institutions such as Countrywide Financial (CFC, news, msgs) and Washington Mutual (WM, news, msgs) could certainly go under or be purchased for loose change by larger competitors. The nation has far more banks than it really needs, and these two institutions -- and many others -- could easily have their books of business absorbed by competitors.

2. Banking bargains

Growing fears of bankruptcy will have devastating effect on all financial institutions regardless of their solvency and relative merits. Expect the bargains of a lifetime to develop in the stocks of certain financial companies as babies, plumbing, bathmats and floor tiles are thrown out with the bath water.

A couple to consider are Leucadia National (LUK, news, msgs) and Pzena Investment Management (PZN, news, msgs). On any big down day or series of them, buy some shares, throw them in a drawer and don't look at them again for three years.

3. Food rules

In 2008, grain will become recognized as the new gold, agriculture companies as the new tech stocks and the Mississippi basin as the new Silicon Valley. Many fertilizer and seed companies' shares did very well in 2007, yet you ain't seen nothin' yet. Farm-focused companies combine innovation with scarcity, and the result is strong growth that's unlikely to abate.

Droughts in Australia, China and Ukraine have slashed crop yields this year, pushing wheat and soybean prices to record highs. Meanwhile, the demand for corn and sugar cane as feedstock for soaring U.S. and South American ethanol use is hitting a wall in the lack of cropland and water. Since ethanol use is mandated by government and has become an increasingly inexpensive alternative to crude oil, thinning supplies are being allocated by price.

Schroders asset manager Christopher Wyke told Bloomberg he believes "we are in the early stages of a rally that could last 20 years in agriculture" as prices "are historically cheap."

Commodity experts say agriculture rallies typically last two to four years and push prices up as much as three times. My list of companies to take advantage of this trend hasn't changed since I first wrote about it last year. On dips only, consider Monsanto (MON, news, msgs), Mosaic (MOS, news, msgs), Potash of Saskatchewan (POT, news, msgs), Bunge (BG, news, msgs), CF Industries Holdings (CF, news, msgs), Terra Nitrogen (TNH, news, msgs), Deere (DE, news, msgs), CNH Global (CNH, news, msgs) and AGCO (AG, news, msgs).

4. Credit crunch, the sequel

We already know that mortgage-payment and home-equity-line-of-credit delinquencies are rising steeply along with home foreclosures. Starved of funds by banks, many strapped individuals turned to credit cards, and now delinquencies in these payments are also rising rapidly. Hedge funds, which heavily borrow to augment returns, are also feeling the effects of credit starvation, as are ordinary folks like dentists, attorneys and manufacturers who depend on easy access to loans to expand and fund their businesses.

Expect credit card companies such as Capital One Financial (COF, news, msgs) and American Express (AXP, news, msgs) to sink to new lows in the first half of the year as they write off losses from deadbeat customers and announce a shrinking of lending opportunities.

Meanwhile, expect to learn a new term for your growing credit lexicon this year: Pfandbrief is the term for a type of European asset-backed security that has long been considered the safest type of bond on the planet. Stresses are developing in its $2 trillion market, however, as home loans sour across the continent, so beware of major German banks, including Deutsche Bank (DB, news, msgs), that trade on U.S. exchanges.

5. Default swap snafu

A relatively new security called the credit default swap, or CDS, is the bond market's equivalent of homeowners insurance. If you own a corporate bond and worry that it might default, you buy CDS contracts to hedge your exposure. If the bond fails, an investor to whom you've been directly paying the equivalent of insurance premiums owes you, typically, $10 million per contract. Hedge funds have run the market for these puppies way past the $1 trillion range because they've also become a way of betting on the potential for bonds' default.

Yet there's one teeny-tiny problem: CDS contracts are largely unregulated and have never been tested in a crisis. No one really knows if they are enforceable or what will happen if counterparties suffer bond losses so great that they're unable to make good on their CDS obligations. If CDS contracts are not fulfilled, banks' exposure to losses might be much higher than anyone has anticipated.

That's just another reason to continue to avoid the bank stocks this year orbet against all of the banks in the S&P 500 Index ($INX) by shorting Select Sector SPDR-Financial (XLF, news, msgs), an exchange-traded fund.

Continued: 5 more predictions

 1 | 2 | next >