FYI | Jun 18 2008
By Greg Peel
Doomsayers are not uncommon in any market, particularly in times of turmoil or even in times of excessive good fortune. Technical analysts are usually the first to make the call to start building an Ark as soon as one interpretation of the tea leaves sends out warning bells, often only to find that – shucks – it was not the beginning of Wave 5 after all but really just the Fibonacci retracement of Wave C, or some such thing. Flamboyant investors such as George Soros can also get absorbed with their own power, as Soros admitted to doing after calling the end of the world in 1997, and then of course there are the so-called “perma-bears”, of which Morgan Stanley’s Stephen Roach is the patron, who can call a crash for so long that eventually, statistics suggest, they must be right.
But there is little doubting the world is currently very jittery as stock markets fail to recover from earlier lows, credit markets just seem to keep being bogged in the mire, and now inflation is running rampant at a time when global economic growth is slowing. So it is not without consideration that the Royal Bank of Scotland should suddenly issue a Crash warning, and who better to break the news than the London Daily Telegraph’s serial doomsayer, Ambrose Evans-Pritchard.
The RBS has advised its clients to brace for a fully-fledged crash in global stock and credit markets over the next three months as inflation paralyses the major central banks, Evans-Pritchard reports. “A very nasty period is soon to be upon us,” suggested the bank’s credit strategist Bob Janjuah, ”so be prepared.”
The RBS report suggests the US S&P 500 stock index is likely to fall by more than 300 points to 1050 (22%) by September as “all the chickens come home to roost” from the excesses of the global boom, with contagion spreading across Europe and emerging markets. Such a slide, on top of what has already occurred, would represent one of the worst bear markets over the last century.
The most unnerving thing about Janjuah’s assertion is that this time last year the analyst made a similar warning call about an impending global credit crisis. He has been feted in the City ever since.
Janjuah expects Wall Street to rally into July as the effects of the US government’s fiscal stimulus package continues to provide momentum. While it might have been the case that Americans would put their stimulus hand-outs to good use, such as paying down debt or saving the money, the recent monthly US retail sales figures proved emphatically otherwise. So when the music stops…
The US Fed and the European Central Bank both face what Janjuah refers to as a Hobson’s Choice – which is defined as a free choice where only one option is offered. Faced with the prospect of workers losing their jobs and being refused credit as the economies of the US and Europe slow, central bankers cannot respond with “easy money” (rate cuts) because oil and food costs are pushing headline inflation to levels which are unsettling the markets. Inflation is the enemy of any investment, as it erodes profit and capital over time. The higher inflation the faster money is lost without actually doing anything. So the world may just have to set itself for much lower global growth in order to beat the inflation menace, Janjuah suggests.
But if the central banks fail to hike rates in the face of higher inflation, risky assets are no longer worth holding as the required return to simply break even on the investment is increased by the higher level of inflation. The response is to sell stocks and bonds and move into cash. Cash does not conquer inflation, but it’s better than losing money when investments are sold down.
“The Fed,” says Janjuah, “is in panic mode”. It is true that one minute the market is expecting the Fed to cut rates, the next minute to hike them, and now to do nothing.
However the ECB seems determined to raise its cash rate and fight inflation at the expense of the wobbling European economy. Already consumer demand and confidence in Europe are showing signs of crashing.
The good news – if there can be good news – is that the price of oil should finally come down following the big asset sell-off. But not before debt deflation has set in next year.
Thus spake Janjuah – credit market oracle.
