378: Key criteria point to recession and crash
Crash On The Cards: The US government came out this week as expected and advised they would end quantitative easing 30 June and continue with low interest rates in the medium term. They said inflationary pressures were under control and the US economy was improving. All sound okay on the face of it. Its very important you read ahead now for our objective assessment - we describe our view on why and when we think a market crash will occur.
Recession on the Horizon: All the indications we can see point to a stock market crash and another recession its just around the corner. This is our opinion based on detailed analysis. We give a 70% chance of some sort of stock market crash in the next six months and will now outline the reasons why:
1. Fiat Money: Firstly - $2 Trillion of printed money has been pumped into the US economy which has hardly got the US economy moving. Unemployment is still rising. Real Estate prices are dropping, even though interest rates remain at 0.5%. One of the key reasons for this is that the private sector now making gigantic profits is not re-investing the proceeds because they are scared about what is just around the corner. They lack confidence to put large amounts of money on the table and are worried about interest rates rising. These companies are hoarded the cash, give some away as dividends to shareholders, and only invested overseas. Furthermore, a lot of this money has gone into speculation of commodities - further deteriorating the US economy by driving up energy input prices.
2. Pumped Up Stock Prices: Because profits are high, this has fed through to stock market prices (price/earnings multiples) - the stock market has sky-rocketed to very dangerous levels since the early 2009 low point. The Dow has risen from 6600 to 12800 - gone up over 100%.
3. Increasing Deficit: But the US deficit has increased not decreased. The USA is now running with a $1 Trillion annual deficit. It's spending is £2.75 Trillion but it's income from taxes despite these massive short-term profits is only $1.75 Trillion. This is about 10% of GDP the same levels that Greece is currently running with also the UK. Dangerous levels - not worthy of an AAA rating.
3. No Plan To Reduce: But the USA has no concrete plans to reduce the deficit instead the deficit has been revised up on a six monthly basis since the 2008 financial shock. Medicare, military and oil import expenditure is totally unsustainable and in our view will lead to a dollar crash and ultimately a financial crash. No wander Standard & Poors put the US on credit watch for a downgrade from their AAA rating. Weiss Rating's today advised that the US rating should be CCC in their objective view, just above junk status.
3. Dollar Standard: Remember that gold used to be the global currency standard. Then this was decoupled after a brief period of UK Sterling being the standard - then Dollar has continued to be the global currency standard since. It was initially backed by oil reserves, coal, gold, high-tech and a booming economy. This has changed since the 1980s beyond recognition - oil reserves have depleted, the high-tech boom has played itself out, and debt has sky-rocketted. Manufacturing has moved to China. But lets just look at a couple of scenarios:
· The Chinese currency decouples from the dollar the dollar would crash as people bought the Chinese currency
· Oil is priced by OPEC in a basket of currencies the dollar would crash as people switched away from the dollar
· The US gets a downgrade from its AAA rating the dollar would crash
Risks: All three of these scenarios are not exactly likely in the next few years, but lets just say in three years time if oil prices stay high, one could imagine one of these scenarios playing out if not two if contagion took hold. No other country can just print more money to get itself out of trouble and get away with it. Its only because of the previous US reputation that the current Administration has managed to get away with this. But as the US declines as a super power and military power, its likely the dollar will continue a long decline and currencies like the Swiss Franc, Norwegian Kroner, Australian Dollar and Canadian Dollar will increase in value against the US Dollar because these currencies are backed by hard assets and resources and run with healthy budget surpluses (oil reserves, gas reserves, coal reserves, metals or gold).
Printing Pressed Stop: You see, the immediate problem is when the Fed stops printing money 30 June and stops buying it's own debt the interest rates will have to sky-rocket to attract investors against risky dollar debt, particularly as no deficit reduction plan can be agreed. When interest rates rise, profits drop, businesses get into trouble and the stock market should therefore crash.
Fiat Money: We believe the only key reason why the US stock market has doubled in two years is because fiat money has been printed and used by speculators on risky assets to make a fast buck. In a way, this was the Feds plan to stimulate investment into risk to create some inflation. But its actually created a huge bubble that is very likely to pop very shortly. Why should the value of US companies double in two years - let's be honest and just admit it - it makes no sense.
Dow Jones At Record: Every time we see the Dow Jones rise further above 12000 we just think bubble and when will it pop. May be we are too simplistic or too honest but its an accident waiting to happen and many normal small investors and pensioners are going to get severely burnt unless they get their money off the table quickly.
Getting Out: The first people to get out will be the big investment banks and wealthiest big investors. Anyone with pensions, unit trusts or small equity amounts will get burnt just like they always do. By the time the average punter realises a crash is on it will be too late. It might happen in a few minutes or a few hours. Not enough time to react. When it starts, people in the know will talk it up as a buying opportunity, but it will only drop further. You have to get out now now yes now before the crash.
Printed Money Being Used In The Wrong Place: Another reason why we think the US is due for a hard fall is because printing money and increasing the public sector is a recipe for disaster. On top of this, the current administration seems intent on banker bashing and oil company bashing. After ten years of steady oil investment, US oil production actually started to increase in 2009 but this has all been massively set back by the current energy policy which is frankly a mess. Plus the offshore ban on drilling. Oil import bills will keep rising and the administration is very unlikely to survive through to end 2012 if gas prices are over $4/gallon. The average American uses ten times more oil than a Chinese person and it affects their consumption patterns so much, it will likely lead to a US recession especially if US based oil prices rise above $120/bbl. As employment drops, oil demand drops. Unemployed do not drive around and spend heavily at shops. They also dont use energy at work. There is a very close correlation between employment and oil usage. Yes look no further than the Fed if you want to know who pumped up the oil price and stock market prices the fiat money having an unintended consequence. Far from creating jobs, its developed a bubble, raised oil prices and created no jobs surely someone in the Fed could have predicted this?
UK Recession: As for the UK its laughable how people looked at the meagre 0.5% GDP growth in the last quarter and say the country is growing. No the snow in Q4 2010 had a massive economic impact keeping people at home and slowing business then in Q1 people had to make large purchases and go about their normal business again. We believe, thats the only reason why the UK grew 0.5%, it was just a rebound from a recessionary quarter. Everyone expected a bit of a rebound. In the last three quarters, there has been zero growth. Any hiccup in the next few months equals a recession. We already know there is a massive hiccup namely high oil prices and all the security problems in North Africa and the Middle East. As the summer approaches a slower growth period normally starts. Meanwhile the tax shock of increasing North Sea oil taxes will lead to many cancelled oil projects and a slowdown in oil production - we expect GDP to drop in Q2 and Q3. Then by end 2011 everyone will need to acknowledge that there is another recession. Despite Sterling massively declining in value in the last few years, exports have not really risen significantly and the service lead growth is likely to be temporary stimulated by the fiat $2 Trillion that the Fed has printed in the last three years along with a spike in commodities prices. It only needs a stock market correction to wipe out the UK service lead economic recovery. As oil prices and stock market prices drop - it will kill any service growth in the UK - this is our base prediction.
Oil Prices Again: The other reason why we think there will be a stock market crash and recession is that oil prices are now over $120/bbl (Brent) well over danger levels. It's been too high for too long. Goldman Sachs are right and Barclays are wrong in our view its time to get out of oil and commodities now that prices have stayed well above $100/bbl for four months. Its only a question of a few more months before inflation takes hold, prices start blowing off, import costs swell debt levels and a stock market crash triggers another financial meltdown. Every time oil prices spike a recession happens period. There is no example of when oil prices spiked and a recession did not start in western oil importing nations since 1950. The simple fact is our lifestyles and massive consumption use far to much oil for the value we create in western oil importing nations too many people burning around in cars but not adding value just burning expensive oil that is running short. Inefficient non value creating consumption we call it. Lots of people "swanning around" - delivering zero and eroding value.
Peak Oil Bumpy Plateau: As far as Peak Oil is concerned, some of the Peak Oil doubter point to an interesting statistic that oil production last month was higher than at any time in the worlds history. Wed like to explain our view on this because we are of course Peak Oil advocates. What we have always said is that since mid 2005, oil production has been on a bumpy plateau. The first peak was for crude oil in 2005. The second Peak was July 2008 for oil liquids (including biofuels and natural gas liquids that rose in production levels whilst crude declined somewhat). The third peak is about now because oil prices have skyrocketed to $125/bbl (Brent) and everyone is producing at maximum rate except Saudi Arabia. This is the bumpy plateau we have been describing for the past five years and this oil production spike will be temporary, probably only a month. It will drop back by year end. We are on a plateau and the downside risk of a sudden big drop in overall global oil production is far higher than a rapid expansion of oil production. Time will prove us correct on this one we maintain our view based on our unique world oil production model (of every oil producing and consuming country) that total oil production will stay within a +/-10% bracket from 2005 levels through 2011 thats a plateau in our opinion not an increase.
Diesel Shortages: The other aspect of oil worthy of particular note is that there is a shortage of light low sulphur crude oil the feedstock that is ideal for refining into diesel. There is consequently a shortage of diesel globally. Diesel usage has sky-rocketted in the last ten years for trucks, cars, tractors and power generation (temporary and semi-permanent). We see light high quality oil prices continuing to increase as diesel shortages intensify until the recession begins again in western developed nations. Russia is suffering diesel shortages, as are India and China a serious situation that is little publicised. This will lead to lower productivity, higher prices and be another factor helping tip the west into recession.
Greece: The trigger for the crash could very well be Greece. There interest rates have sky-rocketted recently to 25% because everyone is half expecting default or debt re-structuring. If there are problems re-structuring this debt it could trigger another bout of Euro-contagion and a financial meltdown not just in Europe but also into the USA and UK. The underlying reason why Greece has not been able to get its deficit below 10% of GDP despite massive austerity measures is because of its huge oil, gas, electricity and coal import bills compared to its output production. Greece does not produce much, but consumes masses of commodities a consumer economy built on very shaky foundations. But they are not the only ones. Further afield are Portugal, Ireland and possible Spain and even Italy - other examples. These countries had economic booms when they joined the Euro off the back of low interest rates, a high value currency, business reputation of Germany/France and tourism plus a fiat property boom. Now its all ended. Oil prices have risen. Tourism is declining. Public sector cuts are dragging the economies into recession. Aging populations with big pensions contributing little to the country will drag these economies down even further. Ultimately if France and Germany dump these periferal countries from the Eurozone as the Euro experiment fails their currencies will halve in value, with it their property prices - then inflation will start as import bills rise. But at least the economy will be re-balancing and tourism will rise as the cost to visit drops for British, French and Germans visitors. Frankly we cannot see a pretty end to the Greek debt issues if oil prices stay above $100/bbl.
Peak Oil: Again, its another sign of Peak Oil the underlying cause of the Euro-contagion is actually Peak Oil. The Europeans import $1 Trillion of oil a year thats massive. As much as the US deficit. And they simply cannot afford this oil especially if they do not manufacture anything worthwhile like Greece. Sorry to be so harsh, but if you have any property in Greece, sell it quickly in Euros and get your money out before not only the property crash happens in earnest but also the currency crashes as well - as Greece is booted out of the Euro. The same is also true of Portugal where property prices are unsurprisingly now in free-fall - agains, if they get dumped from the Euro, they will halve in value again and yes, we are being serious. The smart property investors got out of Portugal a long time ago. And dont be temped either by Spain and Italy at the moment there is a significant chance these far larger economies could go a similar was as well if severe contagion takes hold. The remaining Euro block could be Germany, France, Austria, Holland and Denmark.
Ireland: As for Ireland, it's a complete basket case. A deficit reported this week of -25% is horrendous and expect property prices to drop in all parts of Ireland. Irish property prices would also drop in Euro or Sterling terms far further if Ireland left the Euro of course. In some ways, Ireland looks in the worst shape a massive property boom with bubble that popped with a government that dear not increase corporate taxes and does not want to seriously reduce the public sector deficit. Regrettably the economic hardship is likely to spill over into Northern Ireland and one might expect an increase in terror attacks. The correlation between economic wellbeing (employment) and terror is high and the many years of hard won peace are being risked now from this economic hardship and disparity in wealth. Of course, any increase in security risks will send house prices tumpling in Northern Ireland its already started back in 2008 and does not look likely to stop at least in the medium term especially after the recent serious of bomb attacks.
Baltic Dry Dock Index: We checked this index a few days ago. Its looking dangerous. As you might know, the Baltic Dry Dock Index is often used as a leading indicator of future recessions. It worked very well in predicting the 2008 recession - it fell 12 months before Lehman Brothers in August 2008. In the last few months, the index has steeply dropped 40% and is languishing close to 5 yearly lows. It points to a recession just around the corner or at the bear minimum a severe slowdown.
Dow: The Dow Jones has been rising steadily into the 12800 range and it all looks stable on the face if it. But from our intuition and experience this is just when one needs to bail out and head for the hills. We think the Fed is propping the whole lot up buying on the dips. Giving it support. We dont know this for a fact its just a bit of intuition. It all looks suspiciously stable if you know what we mean.
Sell In May And Go Away: As they say, sell in May and go away. We expect a massive sell-off starting early May. The period up until end of May is a very risky period. If the stock market can survive without a crash through into June, then it could just hang in there for a while longer. But our logic would suggest that people will bail out in May for the summer. All those retiring baby-boomers will want to pull their money off the table one last time before the printing presses stop end June. Then relax on their boats in the Med and Florida. So get out while you still can!
We hope this guidance has been helpful. We also hope we are wrong. No-one likes to see a crash. Just make sure you reduce your exposure to it as much as you reasonably can. We just cannot see things rising much further and we really think things are due for a big drop.