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 MARKET REPORTS |
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Economics
US breaks from booming global economy
December 19, 2007
Clifford Bennett, Chief Economist, Sonray Capital Markets
There is a frenzy about today, particularly in currency markets, that the
US economy is just fine and the central banks and governments will
save the day. The truth is the forces now in play are not fully
understood by anyone, and they are most certainly more powerful than
any government intervention in the free market process at this point.
Governments can influence markets of course, but not when a crisis has
gathered momentum the way this SIV debacle has. As former Chairman
Greenspan has said, artificially interfering in the sub-prime market at this
point will only prolong the agony.
When any market has a significant correction it does so as either a very sharp
sell off with a lot of intense pain for a brief period, or, as a long drawn out
process of a more moderate pain level. We have been seeing the sudden
intense pain correction, and if left alone the forces at play will probably
work their way through and out of the markets in a matter of a few months.
The US administration seems to be about to create a situation of dispersing
the pain to all tax payers, and thereby expanding the impact of the sub-
prime fall out more broadly, and as former Chairman Greenspan has
suggested, prolonging the process.
This is not a great outcome for the US economy. Rather than suggest
everything is OK because the US administration is going to get semi
government organisations to buy bad debt at a face value loss, as many
commentators are today suggesting, my view is that with the Fed hand
cuffed by a momentary spike in inflation, this compounding market
intervention by the administration just makes the outlook for the US
economy all the more dire.
Treasury Secretary Paulson’s background in banking and financial institutions
is obviously a key component of these latest developments. It can be the
case that financiers over emphasise the importance of financial institutions
well being and profits to the broader economy. We are not facing an annual
loss from any of the major financial institutions. We are facing a mark to
market reality that has previously been avoided via complex SIV s. This is a
healthy and normal part of markets, and the process should be left as such.
It is the case that there is flow on to the broader economy, but in both
positive and negative ways. The tightening of credit away from sub-prime lending is a very healthy development. The falling value in home prices,
rather than financial institution losses, is where the real risk to the economy
is. This is however again a normal part of market cycles. Anyone who says
property, or equity, or any market always goes up, has never studied history.
Naturally the more evolved and efficient a market, the less volatile the
swings and displacements. This is desirable, but it is not achieved through
reactive government policies aimed at supporting the balance sheets of
profitable risk taking financial institutions.
We should also be careful to assume that there is a silver bullet solution to
the crisis. It is not really a problem of funds being available. It is a problem,
a crisis, of trust, between the major financial institutions themselves. Simply
pumping more money into the system, where people are still reluctant to
pass it on, is not a solution. It certainly helps and it is good that the central
banks have done this, but it is not a total solution as we have already seen.
The ugly perhaps truth is that this crisis will only pass with the passage of
time, after proper mark to market valuations have been made across the
industry and all losses fully aired. Then institutions and banks will again
begin to feel comfortable in lending to each other. For the moment the level
of uncertainty about the true state of the balance sheets of all financial
institutions is simply too great for anyone to feel fully comfortable.
The outlook for the US economy remains a flirting with zero growth during
the first half of 2008, but not necessarily a recession. Global growth will
experience a momentary set back in pace but the rest of the world will
recover more quickly than the US. The US will not lead the way in the
coming year as it once did, but more or less in a sense be set adrift by a
rest-of-world booming economy.
Our forecast then for a high risk of an accelerated decline in the value of
the US dollar over the next six months remains in place. Similarly our rest
of world equity markets bullish outlook remains in tact, on the basis of
robust non-US global growth, and continued strong demand in commodities.
The current sell down in US equities accurately reflects the discomfort
businesses have about unfolding events and the outlook for the US economy.
The rest of world equity market is following suit out of a pattern of
behaviour habit, but will begin to rebound as further economic data over the
next few months confirms the resilience of the global economy to this US
slow down.
In a nutshell, volatility in all markets will remain high. Do not be in a
hurry to pick the bottom in equity markets, but it will occur, probably
firstly in Asia. In currency markets there really is no good news for the US
dollar on the horizon, despite a lot of celebratory flag waving.
Key Forecasts:
- Fed will cut 25 points in March or April when this one off spike in inflation has
clearly passed.
- US economy will flirt with negative growth Q1, Q2.
- US equity markets remain at risk near term.
- China to remain a powerhouse.
- Global economy to remain firm.
- Commodities volatile but bullish.
- Gold target at US$495, US$800 achieved, US$1100 next.
- US dollar to continue accelerated collapse next 6 months.
- Carry trade is old news and over, USD/YEN to decline to 103, 97.
- RBA to raise rates to 7.25% in H1 2008.
- Australian dollar will continue to climb, 93 cent target achieved,
next parity $1.00, but in 2008, then 1.08 1.12 in following year.
- Global equity markets may suffer minor drag from US market
weakness occasionally, but remain strong.
- Australian equities increasingly aligned to global growth. 6,900 7,350 in 2008.
More articles from this edition of CompareShares:
Investing: How investors will be impacted by a Rudd Government
Stock picks: Fund manager stock picks: WPL, CCP & WWA
Stocks: Stocks and sectors set to beat the market in 2008
Book Review: Trade Your Way to Financial Freedom
Resident Trader: Handling a trade dispute with your broker
Markets: US breaks from booming global economy
Expert Panel: Why it may pay to buy shares before the ex-dividend date
Debt: Super won’t help mortgage woes
Rates: Rising costs add to rate risk
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