The 2009 New Year is upon us, and I have 5 financial predictions for this year.

1. Commercial Real Estate: Yes, I believe commercial real estate values will decline in 2009. We've all heard the dreadful numbers behind retail spending for the 2008 Christmas season. And even worse might be the consumer spending projections for 2009. And, a couple of large retailers (Mervyns and Linen N Things) have announced they are going out of business. Even Starbucks is closing stores across the country (I guess we don't need one on every corner). With all the bad news behind retail spending and the retailer's profitability, everyone is forecasting commercial real estate values to decline in 2009.

What I haven't really heard in this area of analysis is the independent retailer or restaurant owner. The independent or mom and pop retail business or restaurant is struggling, and probably more so than the major retailers. The typical small business owner doesn't sign long term leases, so their lease or rental space costs in the past few years have gone up sharply, while at the same time they have experienced an increase in variable costs.

Then the retail spending slow down was upon us, which means their gross revenues fell, and with the higher operating costs, they have significantly lower net profit margins. Some are operating with losses, and burning personal net worth to remain in business.

While the major retailer struggles, and closes down or closes low margin stores, it's the independent retail business or restaurant closings that will exacerbate the commercial real estate problem. The simple reality is: If this country is not going to spend like a drunken sailor on leave, we have far too many retail businesses and restaurants (auto dealerships are a perfect example of too much). The small retailer has two issues of far more intensity than the large companies: First, most independent or mom and pop businesses are poorly capitalized, which is a necessity of survival in a downsizing economy/industry. Second, financing for most is almost impossible in good times, and given the current banking environment, well good luck finding a loan from a bank for most small retailer businesses. In some cases, I've already seen some banks pulling their credit lines from small businesses.

All total, between the major retailers and the independent or mom and pop retailers, we should see a significant increase in store closures during 2009. This will create two problems for commercial real estate owners: First, vacancy rates will rise. I already see multiply vacancies in my home town's retail corridor, and we haven't seen that much vacancy in years. Second, as vacancy swells, lease rates will drop. Commercial real estate owners will need to become very competitive to find tenants to fill vacant space within a building.

Commercial real estate values are driven in large part by the net income they generate. So, if we are to expect less income from both fewer tenants and lower rental rates, we should expect the value of these building to fall. Some of the types of commercial real estate that should get hit the hardest: Commercially zoned land (land values should get hit the hardest as development grinds to a halt, as inventories of space to lease increases, and land will not be needed for future development). Single purpose type buildings: In this area I have a few examples: It's very difficult to lease out an empty auto, boat, or RV dealership type property, and so many are failing or on the verge of failing. We are going to see a lot of empty dealership type properties. I've noticed a couple around where I live. We are also going to the see big box retailers like Mervyns and Linen N Things close, and there are other large retailers considering closing some stores. These companies lease large spaces that will be difficult to fill, as their competitors are consolidating and there will be little demand for this space coming available.

Commercial real estate lags residential trends by 1-2 years, and we have stretched that matrix to its fullest, and yes, in 2009 the commercial real estate trends will correct and play catch up to residential real estate trends. I'll be the first to admit, that as a prediction, this one is kind of a no brainer, but I wanted to approach it from a slightly different perspective by focusing on the small retailer, and, it's a component of prediction number two.

2. Community Banks: The community bank world will see a rise in delinquent loans.

I've worked in the finance/banking world for almost 20 years, and in the banking industry, there are essentially 3 different sizes of banks. There are major banks, regional banks, and small or community banks. They all have slightly different issues currently.

The major banks (think Citibank and Bank of America) are the institutions with the toxic paper on there balance sheet, which has eroded their net worth. This toxic paper issue on the balance is concentrated for the most part in the largest banks.

Regional banks are typically banks that serve a fairly large regional territory. This territory might be a few small states, a large state, or a large region within a state. They were a significant source of construction and land development lending during the boom in real estate, and the subsequent real estate bust has left these banks with loans on their books that have inadequate collateral to cover these large loans. This has impaired their balance sheet and eroded their net worth in a different way compared to the major banks. In the regional bank sector, think of Indy Mac as an example.

The community bank is typically a bank with 1 to 5 branches serving a small geographic area. They tend to concentrate their lending in commercial real estate (office space, retail, light industrial, etc.), and business loans (lines of credit) to small/medium businesses. Since the small bank has not been so heavily tied to residential lending or residential construction lending like the majors or the regional banks, they haven't had the same issues or at least its intensity, and have for the most part lagged the industry to some extent as it relates to balance sheet issues.

A typical small bank might have 50-80% of its loans secured by real estate. Note: There is one major difference from residential lending, which is the typical commercial real state loan requires significant equity (20-35%) from the borrower to get a loan from a small bank, so compared to a no money down loan in residentially lending, there is a large risk cushion for small banks.

That being said, I expect to see two things happen next year that will cause stress on the small bank world. First, I expect commercial real estate values to fall because of higher vacancies and lower lease rates. This change will impair the cash flow to service debt payments and the collateral value behind so many small bank loans. Secondly, as the economic data worsens in 2009, the small business owner will struggle financially, and the poorly capitalize business owner will begin to default on their line of credit with the small bank. Many of these small lines are essentially unsecured.

The problem gets compounded because of the current state of the community bank world. Many of these small banks haven't reached a size and efficiency level to generate a profit and many are still losing money with currently clean loan portfolios. They are not adequately positioned to survive with losses and see a sharp increase in delinquent loans. Additionally, many small banks have loan portfolios that are 90-120% of their deposit base, and have to borrower from the fed to make up the difference. In this situation, a bank is illiquid. Not exactly the structure to have and experience a sharp increase in delinquent loans.

Leverage is still the new four letter word. Note: Not all small banks are the same, in fact there is a great deal of variance in this world and many have strong operations, so this might be a case by case problem. It will depend on the bank's balance sheet, geographic location, and credit quality, as to the significance of the impact of increasingly delinquent loans.

3. The Banking Industry: I believe 2009 will be the beginning of a small wave of bank mergers and further consolidation. Has your bank bellied up to the TARP trough? Has any bank really loaned that money out in any significant manner? Given the economics of the day, would you want to lend that money right now? So, what is all that TARP money going to do? It has to go some where because banks are highly leverage entities, and money sitting around in cash provides no returns to shareholders, and provides no economic benefit to the country. So, what's going to happen with this money?

The industry is too large in the number of banks for the current economy. I think the banks that have hit the TARP up are using that money to repair their balance sheet for 2008 and year end reporting. And, I expect them to use that money in part in 2009 to buy other banks and put that money to work in acquisitions.

Non banks, like Goldman Sacs might go on a buying spree to buy their way into being a bank. Major Banks will use those funds to expand their foot print and buy regional banks. Regional banks will buy other regional banks to create a larger entity in an attempt to remain independent. Regional banks will buy community banks to increase their foot print within their regional zone to make themselves more attractive for sale to larger banks. Community banks will merge to create significantly larger efficiencies of scale and remain competitive within their market place. Note: There are some banks with balance sheets that just won't make it, and the FDIC will take them over next year.

Essentially, given the lack of organic growth to support all the banks in the industry, we need to see consolidation to create stronger more profitability banks that hopefully will provide the foundation for a stronger industry upon which we can start lending from to support the country and our economy.

4. Stock Market: I expect the stock market to continue its bottoming process. This process includes a grindingly sideways market with an upward bias for a few weeks or few months. The market needs to work off oversold conditions, which will continue to frustrate market participants. Then, we should see at least a hard retest of the lows, or in my opinion the markets will make new lows. I don't want to pick timing for this event yet, because it's a technical process that should be the consideration, and patience is needed.

Above is a monthly chart of the Dow Jones over the past 10 years. We've had a sharp correction compared to that of the last correctional period (2000-2002). You'll notice in the months of October-November-December of 2008, the markets have sold off below the 200 month moving average (red line-around 8,500), but could not close below that. This moving average has served as a solid resistance for this correction so far on a monthly closing price basis.

We are wildly over sold on the weekly and monthly charts, but oversold conditions in severe corrections like this can last longer than expectations or prior cycle corrections. That being said, the Elliott Wave structure of the move down seems incomplete on the monthly chart. I'm sure there's an alternative wave count out there that suggests the bottom is in for this leg down from the 2007 peak, as there is always an alternative count to be considered. However, I believe there is more work to do on the down side structurally, and there is plenty of pending bad economic news in the first half of 2009.

Specifically, I doubt that we will get a V-bottom, and a bottoming process and pattern is far more likely (statistically). I'm looking for January and maybe February to provide small monthly trading ranges with an upside bias to work off the over sold nature of the market before we have what I think will be the final corrective phase of the entire move down from the peak in 2007.

5. The U.S. Long Term Bond Market: I expect the bond market to begin a topping process, which will include consolidating at these higher levels and build a topping pattern. During this process, I expect to see smaller highs, which will exhaust this move up as part of the topping process. After which, I expect the bond market to begin a correction. It wouldn't surprise me at all for there to be some linkage in the expected top in the bond market with a new low or at least a firm test of the lows in the stock market in 2009.

Above is an arithmetic monthly chart of the U.S. Long Term Bond market.

The bond market has been in a clear bullish channel for years. This chart reveals some interesting characteristics of the bond market:

1. Almost half of the peaks and troughs have occurred when an opposing peak or trough in the stock market has occurred.

2. I've drawn pink channel lines from absolute peaks and troughs, and blue channel lines from the majority of peaks and troughs. Note: We can clearly see how rare a strike of the pink line is, and how little time it stays outside the blue line.

3. Lastly, each time the RSI was above 70 (overbought), the bond market followed with a correction.

4. The current price level is outside the pink channel lines and the RSI is above 70 reflecting a severe price spike to extreme levels.

Above is a logarithmic monthly chart of the U.S. Long Term Bond market. I've shown this different chart style because it reflects a different channel configuration. Bull markets often trade in channels, and this one is slightly different than the arithmetic chart.

1. It still reflects the bond market has more room to the upside to exhaust itself and strike the upper channel band. That upper band is about $150-155. This would allow for a topping process or pattern that could last longer that most expect.

2. It also reflects the middle of the channel as very strong trend support. In the final quarter of 2008, the bond market bounced hard off this middle trend line at $113. That kind of reversal and strength is rarely the final move. I'm looking for the bond market to exhaust itself and make a topping process.

As long as the treasury market is a flight to safety move for investors, and the US Gov't has a willingness to do anything mentality, I expect this topping process to continue and prices should hold temporarily at high levels, longer than most think. I believe the top in the bond market will link in some time degree (I'm expecting a small lag) to the stock market making new lows or testing Nov. 2008 lows. When the stock market demonstrates a firm bottom and is moving higher the flight to safety move will soon be finished and bond top will complete.

The true wild card in this market is the foreign government ownership of US Bonds. They hold quite a lot of our bonds, and have experience a huge gain and probably need those funds back in their own country. Any significant foreign selling is obviously bearish.

Happy New Year, and hope all is well.