Anticipating a recession
The “R” word is everywhere. It’s being discussed at World Economic Forum at Davos and now we have clients calling in at Orpheus asking us about Recession and how bad it is. And is there a chance that the global depression might be starting. Such worries though important and critical do highlight the mass psychology and how it reads the Federal interest rate cut and subprime crisis as a start of something bigger and problematic.
First and foremost recession is not an event it’s a process. It happens again and again. And when the recession lasts for more than three successive quarters of negative growth and prolongs we call it a depression. We have had one depression in USA and one in Japan from 1929-1932 and 1980-1993 respectively.
A part of market sees this as a sectoral crisis just in the financial sector. But crisis is never sectoral, it’s always linked to credit and is across market. This is why a financial crisis is also called a confidence crisis, as liquidity dries the counterparties panic and everyone wants out at the same time. This is the reason a onetime write-downs might not be enough. New trader’s from Europe keep falling out of the closet. Markets need confidence more than write-down’s. It’s like saying if the FED cuts the benchmark again things will be fine. Some might however look at it differently i.e. if the FED cuts it again we have a more serious problem. In any case FED cut does little to boost confidence, the most needed commodity today. Markets follow their own rhythm, no wonder S&P 500 has rallied on the same day as a Fed rate cut only six of the last 13 times. And if all this was not enough we have Alan Greenspan doubting FED’s ability to avert a recession, everybody seems ready.
But the recession or great depression does not start till we have these negative quarters. All we are doing now is anticipating. And even if we are anticipating are we not a bit too late? The housing crisis started more than a year earlier and has already pushed prices substantially lower. We have more than a million foreclosures. The Philadelphia housing index (HGX) has dropped by 60% from 2005 high and sales of new houses are at 25 year low. Even the subprime has seen a lot of wealth erosion. The overall economic loss is estimated at $ 2.3 trillion. The third indicator, considered as the most reliable predictor of US slow down is the S&P 500, which is still negative for the last seven years as it failed yet again when it reached previous 2000 highs. This suggests that the slow down what we talk about today is already under play for the last few years and that is why anticipating a recession is different from what is happening.
Robert Prechter market thinker compared Dow Jones with Gold and proved that the slowdown is already happening as Dow Jones has crashed 67% compared to Gold over the last 8 years. This he calls as the silent crash. We have mentioned it so many times prior in our write ups saying that though history repeats itself it never repeats in the same way. And this time the slowdown is happening without people around realizing how our real purchasing power is eroding. Gold is near the $ 1000 mark, and Bill Sarubbi, market thinker and world renowned time cyclists puts it at $ 3000 in years to come. What would that mean? That would mean that even if markets locally or globally don’t really crash, the effective value of money will become a fraction of it. And Gold will become the most valuable asset more valuable than real estate or stocks as they are all denominated in paper money. This is already happening not only in America, but across the world. The real value is shifting to Gold and even though we don’t realize this. And we should consider our self lucky if Gold gives us a last dip back sub $ 600 before starting the next big leg up till 2013.
So though America and emerging markets might be witnessing a fall in value compared to Gold, the relative performance still points positively at what has been created over last seven years in emerging markets is more valuable than what America created in the same time. Plus the level of financial securitization in America or leverage as I might like to call it is much higher in the developed world compared to emerging markets. So even if we may seem to come down together there is always a relative performance. And the adjustments to US slowdown are dynamic and happening all the time. Over the last eight years the US dollar has depreciated 87.5% against the Euro. The slowdown is already taking a toll on the purchasing power parity of Americans. So markets around the world cannot be really clubbed together with looming asteroid and recessions, we do need to factor in local relative currency strengthening also.
Simply putting, all this talk of crisis together is a mass psychology creation. And even if we leave the Gold peg behind, the correlations between Global and local markets is an overplayed statistics. What works is only the short term correlations in contagions, rest correlations are weak and flawed predictability indicator. The world will not come to an end even if the US plays down, as adjustments are happening consistently.
In conclusion, we don’t believe anticipating recession can bring over a more serious chaos than what is already happening. Rather we think the mass psychology element highlights an inbuilt positivity to the whole thing. We in emerging markets are still low on critical mass to get seriously burnt with any global slowdown. And the real crisis may still be months away. And even the worst comes earlier, we can laugh about these terms like the late president Reagan did, when he said, “A recession is when your neighbor loses his job, a depression is when you lose yours”.