Monday, November 17, 2008

Greenspan's monster eats Goldman's BRICs

The business cycle, as we have so vociferously been reminded, is not dead.

Not only is it alive, but it's now bigger and stronger than ever!

For over a decade, it had become conventional wisdom to assume that rapid growth among the developing economies of, inter alia, Brazil, Russia, China and India (or BRICs, as Goldman Sachs coined them) had become a permanent feature of the global landscape and would be strong enough to compensate for any slowdown that might occur in advanced economies.

Not only would a slowdown in, say, Germany or the US be mitigated by growth overseas in India or Brazil but that such a period would bring with it a redistribution of wealth from rich to poor (i.e. if one group of economies is growing while others are shrinking then a rebalancing of wealth would follow).

And up until the middle of this year everything was going according to plan.

Then oil stopped rising and everything went into reverse, especially among the BRICs.

Two questions now arise (to which you will struggle to find anyone capable of providing a clear and convincing answer):

1) Why did oil prices rise to $150/barrel?
2) Why did oil prices then more than halve in four months?

A third question, to which it's always fun to see people attempt to provide an answer which they can believe:

3) Where will oil prices go from here?

While it would be tempting to try and predict where oil prices will go or explain why they have risen and fallen in such dramatic fashion, it's more important to realise what just happened in the context of oil's gyrations, since much of this backdrop helps to explain why movements in oil and other financial assets follow the paths they do. This will also explain the meaning that's hiding behind the title of this post.


In 2001, Goldman Sachs economist Jim O'Neill predicted that the BRICs would be among the world's most dominant economies by 2050.

This ambitious prognostication helped create one of the largest proverbial bandwagons in history.

The number of people searching for the term "BRIC" on Google has grown every year. With a growing intellectual curiosity came a growing financial interest. The smart money started going South and East.

Then the stupid money followed.

At the same time as money was flowing into emerging markets, the US was facing the prospect of deflation (falling prices everywhere), something it hadn't seen since the Great Depression.

As now Fed Chairman Ben Bernanke, said at the time, interest rates could and should fall more rapidly than in normal times to avoid such a thing from happening.

And that's exaclty what they did. Until mid-2004, US interest rates remained at 1%.

What then Fed Chairman Alan Greenspan didn't realise what that investors would use the money they could borrow so cheaply to invest in emerging markets, which Jim O' Neil had predicted would offer sustained economic growth for at least the next generation.

Greenspan was creating a monster, and it's color would be green.


With the volatility we are now seeing in financial markets it has become a fruitless endevour to bet on the next move, up or down.

However, it's important to not lose sight of the fact that we are seeing something no different to the bursting of any bubble gone before.

What caused the bubble in oil and emerging markets was a combination of a low cost of borrowing and gullible investors.

While all bubbles teach a different lesson, they all result in the same thing: the search for a new bubble. But you can't burst the same bubble twice. And oil prices and emerging markets have both now clearly burst.

Only time will tell what Bernanke's monster will destroy...

Tuesday, November 04, 2008

Be careful what you hope for

Hope can quickly turn into hopelessness.

The very act of hope brings with it an expectation that things can and will get better.

Each passing day that hope fails to deliver is one step closer to losing hope.

Can President Obama, with his promise of hope, make things better?

If it was 1982, perhaps. If it was 1992, perhaps. If it was 2002, perhaps.

It isn't. It's 2008 and things can and will only get worse.

Unfortunately, the situation will get worse for precisely the people to whom Barak Obama has offered his special brand of hope: the black, working class.


Obama's key pledge to the US electorate was to cut taxes for 95% of working Americans.

The key word here is working.

US jobs are currently being lost at a faster rate each month and are likely to continue to fall faster.

The greatest cause of poverty in any economy is not low wages or high taxes but unemployment.

The current environment is particularly severe as those people most at risk of losing their jobs have already lost, or are very likely to, lose their homes too.


In the coming months what we could see is the type of humanitarian disaster created by Hurricane Katrina but on a national (indeed international) scale.

How bad would an African-American President look if this occured on US soil?

Bad enough to lose the election in 2012.

The only question remaining is which lucky politician will inherit a situation in 2012 similar to that in 1982, 1992 or 2002? That's someone who Barak Obama can only hope to be.

Timing is everything after all...

Monday, November 03, 2008

Prologue of a crash

It was over 18 months ago that I made the following prediction:

"The US economic cycle has reached the stage where a sharp slowdown is not only inevitable but likely. While the timing of such a slowdown remains uncertain, it is likely that any investor who remains heavily exposed to equities for the next 2-3 years is unlikely to see any gains over the period."

On that day (April 9th 2007) the S&P 500 closed at 1450. The market then rose by a further 7% to close at 1550 on July 9th.

It then fell and fell and fell.

The market's most recent low point of 850 on October 27th was 40% below where it was when I made my prediction last year and 45% below the high point on July 9th.

You're welcome.


If history were the perfect guide then we would all be justified in piling everything we own into the equity market.

Some professional investors, like Warren Buffett, believe that American companies offer the most compelling valuation at this most difficult of times.

Of course, with global equity markets so highly correlated it shouldn't really matter which one you pick; they all go in the same direction sooner or later!

Unfortunately, there is only one direction in which equity markets will be going in the foreseeable future: down. Why?

For the same reasons I predicted last year and more, namely:

1) Uncertainty about how much lower US interest rates will go;
2) Uncertainty about how deep and how long the US (and global) recession will last;
3) Uncertainty about how much further the US housing market will deteriorate.

If there is one thing that financial markets hate it is uncertainty and the longer it takes for these issues to be resolved the harder it will be to justify rising equity markets.


Willem Buiter, former member the Bank of England's Monetery Policy Committee and London School of Economics professor was quoted in today's Financial Times as saying of people who for months have been pessimistic about the economy:

"Hindsight is useless. One has to look at the information available at the time and the arguments used at the time."

I guess it might be helpful if he read this blog and my posting 18 months ago.

Watch this space, Willem!