Crash – markets take a hit.

Last night’s price action in equity markets was terrible with the Dow Jones off more than 500 points or 4.3% and the S&P 500 falling a full 60 points or 4.78%. European Bourses were not off as materially but with losses of more than 3% it was hardly a comfortable night’s trade.

The corollary of these equity crashes was a fast and aggressive rally in interest rate markets. US 2 year rates are now 0.25% while US 10 year rates are now 2.4%. Australian rates got dragged lower as well and the implied rate cuts over the next year now sits at 109 basis points, basically 4 RBA moves, while the 3 year swap rallied even harder and are quoted on Bloomberg this morning at 4.26% which is truly amazing given the RBA’s outlook.

Yesterday I wrote that only a global catastrophe would lead the RBA to cut rates anytime soon – last night’s moves wasn’t a catastrophe but the preconditions are building and the economic outlook is deteriorating.

Now we have taken a lot of flack over the past year with the QE2 induced rally in the markets averting people’s eyes from the true underlying economic picture. I am constantly being entreated by clients and readers to be more optimistic as we are viewed as being too pessimistic. I get that, it’s no fun reading people who are always, it seems, down in the mouth. But this blog and this game is about making money in the markets. It’s about being right not sanguine and unfortunately the type of price action we have seen over the past 4 months and which has enveloped markets since the 25th of July is exactly the types of risks we have foreseen and warned about.

It is not always going to be so, and when it isn’t we will be cheerleading for the bull run. Indeed we believe that at some point in the next 5 years we, those of us in our 40’s, will get the opportunity of our lifetimes to buy stocks for the long run. But now is not the time.

All the while we have tried to be balanced in our coverage and views but we have, at our core, had an underlying belief that unfortunately this thing we call the GFC had a long way to go before resolution. Now we are not overjoyed with this current and future circumstance but as an old mentor used to say – IT IS WHAT IT IS.

So, what is IT and what is going on at the moment? Put simply the markets are waking up to the fact that in the aftermath of the financial crisis where there is a distinct lack of aggregate demand in the global economy driven by government and consumer led austerity the outlook for economies and companies is poor.

Take for example the situation in the United States at the moment. We updated our chart of the number of Americans on “Food Stamps” yesterday. It now sits at 45.75 million people up more than 1.1 million over the previous month – hard for an economy to grow when it has an anchor like that around its neck. Add in a bout of politically induced austerity, which is essentially what the debt debate is all about, and we get low consumption spending and now no growth, indeed pullback in government spending.

Remember how the GDP equation is constructed?

GDP = C + I + G + (X-M). Consumption, Investment, Government, Exports and imports.

So consumption is down, government is going down, who would invest in this economy which leaves it all up to net exports. But not every country in the world can increase their exports, someone has to buy more than they produce, that is how it works.

If we get in our rocket and look down on the planet as a whole we can essentially forget about the X-M component when we are interested in total global growth. So what we end up with is C + I + G. And just like we are seeing in the Australian economy no amount of Investment (if we can find it) can compensate for a lack of consumption and falling government spending.

This brings us back to weak US growth, which the market is waking up to, weak European growth, which everyone knows about and no political appetite or fiscal space for governments to replicate what they did in 2008 and 2009. This is just another more scary stage of what is now the enduring global financial crisis.

The question on everyones mind is what this next stage looks like.

Is there more quantitative easing coming – probably.

Is there more fiscal stimulus coming – probably not.

Will the United States go back into recession – probably

Will Europe be able to cope with its sovereign debt problems – probably not.

Will China get dragged down by this developed world mess – probably, eventually

Will Australia remain immune from the crisis as it has so far – probably not

Will the markets bounce – probably, of course

Are we near the end of the crisis – probably not

Unfortunately the longer this mess persists it seems the further we are from the end, not the closer to it. Circumspection, for now, remains our mantra.

greg@lighthousesecurities.com.au

www.twitter.com/gregorymckenna

This blog is for information only and does not constitute advice. Neither Greg McKenna nor Lighthouse Securities has taken your personal circumstances, objectives or financial situation into account. Because of this you should, before acting on this information, consider its appropriateness, having regard to your objectives, financial situation or needs.

If you do need economic, investment or financial advice we are happy to help.

Please Email the team at Lighthouse at info@lighthousesecurities.com.au or Greg directly on greg@lighthousesecurities.com.au

 

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