I’m an extremely cautious bull on the current markets. Cautious, because, if a few criteria are met, the mini bull market (or bear market rally, if you prefer) we’ve seen since March 2009 could easily tip over and provide the catalyst for the hypothetical “double-dip recession.”
Commentators have recently been pointing out the fact that the VIX is higher recently and that “sentiment is all over the place.” The major profit-taking has already happened and apparently there is now a lot of indecision in the markets. While these are not statistical measures, I do think they are telling us something.
The “official story” that the news media has been following since October 2008 may have largely come to an end. By that I mean the majority of the predictions, forecasts, “if, then” scenarios and expectations have all played out. TARP money has been returned (not all of it, true); businesses are posting slight earnings; consumer confidence is coming back a bit; loan-losses are mostly taken care of. Australia’s raised its central bank rates back from “emergency provisions” levels and in general we’re all back from the brink.
So what now?
In the past week, I’ve listened to one analyst who has provided the most confident report yet that we’re at the beginning of a “mega bull market” and another who has come around to the view (after being neutral for quite some time) that we are likely to see a “double-dip” or “W-shaped” recession (or recovery, if you prefer).
My opinion? The world economy will decouple and improve, but the U.S. is going to take much longer to recover. If there’s a double-dip, it is largely going to affect the U.S. and the rest of the world much less so. Time will tell, but here are some of the main reasons in favor of the double-dip argument.
Potential Causes of a Double-Dip Recession
U.S. Residential Real Estate.
One analyst recently argued that the only major problem still existing in the U.S. economy (or world economy, for that matter) is the systemic problems in the U.S. housing market. A Deutschebank study recently reported that by the first quarter of 2011, 48% of U.S. homes are expected to be under water, i.e., owing more on the mortgages than the market value of the home.
Top this with the next wave of ARM-foreclosures and the “recovery” doesn’t look like much of a recovery at all. There are expected to be another 7 million foreclosures throughout the U.S. continuing into 2010 and 2011.
U.S. Commercial Real Estate.
Commercial real estate, largely in the U.S. but to some potential degree in Canada as well, is widely expected to be running into some problems soon as retailers’ earnings fail to recover very quickly in light of continued consumer spending weakness.
Some analysts have referred to it as the “other shoe to drop,” although we haven’t yet seen it. If consumer sentiment remains weak, it could very well be part of the second market dip.
Oil Prices/USD relationship.
I’ve mentioned previously that whatever gains made on the US export front will be offset by higher oil prices, because oil is priced in US dollars. Global shipping of exports is one big oil suck, so oil prices eat into export profits.
It is also widely acknowledged that higher oil prices might not only be a contributor to economic weakness (by stalling or clipping a recovery short), but some, like Jeff Rubin, have even argued that oil at $147 caused the credit crisis/ Great Recession.
I haven’t heard any analysts who expect to see oil at $147 anytime again soon, but it is not uncommon to hear forecasts of $90 already during 2010. Right now, $80 seems to be an important psychological and technical resistance level. Once safely broken, oil could easily pop to $90 by the end of the year.
Layoffs show only mild signs of slacking. Just this past week, Johnson & Johnson laid off more workers around the globe – and J&J is a major player, defensive company, and excellently-run. Even if layoffs have abated somewhat, there is still the problem of having no new hires on the horizon.
We can talk about a “jobless” recovery all we want, but consumer spending still comprises 70% of the U.S. economy. When higher percentages of these consumers don’t have jobs, we are left with either a shrinking GDP or the US government doing more of that spending on consumers’ behalf.
Reserve Currency Problems.
The US dollar has been the so-called “world reserve” currency since 1944. While many major currencies are held by central banks as part of their reserves, the US dollar has traditionally been the most-held currency and in the largest numbers. Why? Because oil and commodities are priced and traded in greenbacks. Also, traditionally, the US dollar has been perceived as a safe, stable barometer of the US economy (which, during the time of Bretton Woods, was actually the world leader in goods production).
Although the official world reserve currency status seems unlikely to change in the short-term, it is no secret that many central banks have already begun the process of further diversification of their reserves. Just this past week, India bought the largest-ever single purchase of gold from the IMF, sending gold prices up $20 in one day. Buying gold (and thus selling rupees), India is able to “weaken” its own currency against the US dollar.
Everyone is aware by now of the massive inflation in the US money supply since 2008. Although much of this new money has not actually trickled past the banks yet (it’s still sitting in their capital reserves), central banks have begun reacting to what is expected to be imminent inflation following a sustained economic recovery. When the US dollar weakens, it makes every other country’s exports more expensive – so naturally, other countries want to weaken their own currencies downward, too. One analyst referred to this as the “competitive debasement” of currencies. One efficient way to do this is for a central bank to buy gold – it kills two birds with one stone, too, by hedging against the US dollar.
Expect to see continued reserve diversification, gold purchasing, and US dollar weakness.
Another Rush to the Dollar?
It is possible that another market crash might send global wealth rushing back into the US dollar, as it did in October 2008, but I wouldn’t bet on it. If anything, it will cause central banks to rush into gold now that it is clear where the economic troubles really lie and most structural problems have been fixed around the world. For example, most companies and banks have undergone significant cost-cutting procedures, boosted their capital reserves, and put loan-loss provisions in place. Another market crash is not going to effect the worldwide economy in the same way as the first one did.
Zhou Xiaochuan’s Proposal For World Reserve Currency is Accepted by UN (March 29, 2009)
U.S. Dollar Up For Debate At G8 Meeting (July 5, 2009)
Supracurrency Coin Proposed As New World Reserve Currency (July 12, 2009)
China Diversifies Reserves (July 29, 2009)
World Bank: Don’t Take USD Reserve Status for Granted (Sept. 27, 2009)
Sucre, New Latin American Currency To Replace USD for Trade (Oct. 19, 2009)
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