FYI | Aug 10 2006
A little less than nine months ago, highly valued member of the FN Arena team Greg concluded one of his feature stories with a memorable sentence, one that provoked quite some responses from our readers, both positive and negative.
At the bottom of a story that opened with Dante’s famous entrance to Satan’s inferno "Abandon all hope, ye who enter here", Greg wrote: But have no doubt – charting is pure b*llocks. You may send your letters now.
And letters we saw.
We promised the readers a chance to respond. We invited emails, personal insights and experiences. We called it The Revenge of the Chartists. Unfortunately, due to some unforeseen developments (all this was in the pre-FN Arena News era) those plans never materialised.
I think the Revenge of the Chartists is what we are witnessing now.
Many an investor would have hoped that the Federal Reserve Bank announcing a pause in its 17 month streak of interest rate increases would have at least freed up the market’s spirit for a short relief rally. Instead, we’re seeing share prices tumbling, day after day.
As acclaimed market commentator Dennis Gartman says: it is when something positive occurs and the market doesn’t rally one should become concerned for if anything that is a bearish sign.
Of course, there’s room for debate whether the recent Federal Reserve Bank announcement was a positive, with ongoing strong reference to potential inflation troubles in the months ahead. It also doesn’t help that oil experts at Barclays Capital have reconfirmed their view that market expectations regarding oil prices are still too low, and their point is vindicated month after month, week after week.
Gartman has held the view since May this year that US equities have entered a bear period. He uses technical analysis (plus his own gut instinct) to draw this conclusion.
I have written at least on one previous occasion that I hoped he was wrong. Reading his recent newsletters, however, it doesn’t seem like Gartman is going to change his mind though.
Quite a few other technical chartists have expressed their worries and concerns over the Australian share market over the past few weeks. Some of them argued that it wasn’t looking as bad for Australian equities as for the US markets, but since the US tends to dictate the overall trend for the rest of the world, the immediate outlook seemed worrysome, at least.
I visited the Tech Wizard yesterday (soon to be a regular contributor to FN Arena News) he said "Rudi, I am only a little bit worried at the moment, let’s call it mildly cautious, but the longer this situation continues, the more bearish the overall picture becomes."
Similarly, John Bedson, who manages his own hedge fund and who has been a subscriber to FN Arena for years now, believes his charts are signaling the market is currently in shaky territory. (John’s regular contributions can be found in our (more) Sources of Wisdom section).
Greg would say we don’t need charts to tell us the immediate outlook for shares is clouded, we have a daily spot oil price for that. At FN Arena we concur with Barclays. That’s why we are worried about inflation in the months ahead.
This is also why the market finds it hard to believe that this Fed pause will lead to a peak and reversal soon in the US interest rate cycle.
It certainly ain’t over in Australia yet. One release of economic data after the other appears to raise the odds for another 25 basis points hike later this year. We’ve all seen how tough it is for the Chinese authorities to apply the brakes on their white hot economy, a process that still hasn’t generated many tangible results it would seem. It doesn’t look like Australia’s economy is going down without a decent fight either.
The US, however, might be fighting a whole different set of demons. This week saw Nouriel Roubini, Professor of Economics and International Business at New York University Stern School of Business and of online blog fame, declare that it may already be too late to save the US economy from falling into another recession next year.
Now, we all know that in this age of ever present, global encapsulating media, one has to revert to bold statements to stand out and receive the attention one is looking for (that’s why we saw these US$2000/oz predictions regarding gold a few months ago), but I would find it hard to believe Roubini would seek his 15 minutes of fame by making a claim he doesn’t think has any merit.
A while ago he believed the odds of a US recession by year end were about 50%. While that reads like a very scary prediction, we already know from other economists that unless theoretical odds get past the 60%, it usually isn’t worth hiding in an underground bunker just yet.
This week saw Roubini declare the odds have now increased to 70% and that’s when the world starts paying attention, as it should.
The world must prepare for America’s recession, Roubini wrote on Wednesday in the Financial Times. It is already too late, he believes: "The Fed might have been hoping for a soft landing for the economy but instead it faces recession. The implications will be felt globally."
The US recession will be triggered by three unstoppable forces, he predicts: the housing slowdown; high oil prices (yes, he too is in the same camp); and higher interest rates (the reason why the US share market cannot seem to find the way up). Ultimately, the US consumer, already burdened with high debt and falling wages (in real terms), will be hit hard by these three shocks coming together.
More interesting than his Op-Ed piece for the FT, I found, was the preceding blog posting. It was called Four Investors’ Fairy Tales…and Five Ugly Realities About The Coming Severe US Recession.
Let’s have a look, shall we?
Nouriel Roubini believes the experts holding on to the belief the US economy will experience a soft landing are on drugs. Or they drink too much. Or both. Whatever the cause, they are not being realistic. I’ll come back to this a bit later. That’s myth (fairy tale) number one.
Number two: in case things turn out worse, the Fed will come to the rescue by lowering interest rates. Slower economic growth will also lower interest rates. Sorry, but Bernanke and Co are simply behind the curve, Roubini believes, it won’t do. Not anymore.
Roubini is, of course, on the side of the experts who believe the next Fed move will be cutting interest rates again. But it’s not good news.
In 2000, Roubini argues, the Fed found itself in a similar position. It stopped tightening in June 2000 following a series of hikes since June 1999 taking rates higher by 175 basis points. But soon after it paused the economy slumped from 5% to 0% growth. Aggressive cutting followed but the economy nevertheless spun into recession by the first quarter of 2001.
The Fed cannot stop the housing slump either, he argues, and there are several omens to signal the slump in housing will be severe and hit the economy hard.
It is easy to see why he doesn’t believe a hard landing is avoidable.
Myth number three: the rest of the world will be able to de-couple from the US and continue growing at a perky rate. Number four is that the long awaited rebalancing of global current account imbalances is underway and the process will be achieved in an orderly fashion.
Roubini’s doom predictions are centred around the US housing sector. The coming slump will hit US consumers by decreasing their wealth. It is that simple. 30% of the growth in payrolls over the last few years was either directly or indirectly related to housing, he adds.
A weakening US dollar will push up currencies such as the euro and the yen. This will impact on the profits of foreign firms.
His conclusion: the last four global recessions have been characterised by an oil shock and an inflation scare that triggered monetary tightening and stagflation. It won’t be different this time: global business cycles are highly correlated.
Roubini thinks the rest of world can maybe manage to de-couple for a quarter or two, as Europe and Asia are experiencing a cyclical recovery, but a US recession will have a severe impact nevertheless.
And all this doesn’t even mention what else could happen given the large US current account deficits, the rising danger of increased protectionism and so on.
Cash is king, he says, warning investors not to get sucked in by the next share market rally.
Somewhere on my hard drive, I have stored a document by Robert Prechter, once of widespread guru status. If my memory is correct, the prediction, made in early 2005, was for a new bear market cycle to start in March 2006.
Oh yes, that was wrong, wasn’t it?
Let’s hope it was wrong full stop. Not just by two months.
Till next week!
Your admittedly a little worried myself editor,
Rudi Filapek-Vandyck
(supported by the Magnificent Four: Greg, Terry, Chris and Rob)