Successful investing is as much about offense as it is about defense, meaning protecting capital or building defensive strategies for investors / clients and given the exuberance that we have seen in stock markets of late – duly fueled by the Fed’s various money printing programs, I think it might be worth looking at some potential downside plays. Should we prepare for the downside ?
Deja-poo – Have we seen this …… before somewhere ? Sadly 2015 looks set to be potentially another 2008 with respect to a very large market decline in stocks (30-50%), real estate (10-20%) and commodities.
18-24 months of deflation
The underlying driver is that we are currently in last stage of a correction within the 25 year Kondratiev cycle that started in 2000 much as we were in 1998 to 2000. This will create a similar environment for the commodity industry as it did in 1998 to 2000. The current 25 year inflationary cycle which started in 2000 had its first impulse up to 2008/2010. Since then, it has been in a correction (a deflationary cycle) that is due to end around late 2017. Thus, we are now in the final phase of a relatively short-term, but vicious deflationary cycle that will impact global asset prices, starting with commodities and most notably oil.
It is the presence of this underlying deflationary trend, otherwise known as a demand vaccuum, that has allowed the Saudis to push the oil price lower, with the strategic aim of hurting Russia (for its role in Syria), Iran (for its role as a strategic competitor) and the US (for its shale oil business and support of the democratic Muslim Brotherhood in Egypt). The Saudis’ timing is perfect with respect to the deflationary phase at present. Thus there is every chance that their desired goal will be achieved, with Russia doubly impacted by the US sanctions over the Ukraine and Iran’s now limited oil revenue base (even if US sanctions are lifted in the scenario that a nuclear deal is met). Whilst at the same time America’s potential as the world’s biggest oil producer will be severely impacted as the higher costs shale companies are all forced out of business by prices falling below the cost of shale oil production. We would not be surprised in 2015 to see oil spike below $30 a barrel on NYMEX, and the price to remain very low thereafter for the next 18mth, before we see any chance of a sustained recovery.
Conspiracy Theory #1: I and a few fellow Matrix / Bourne fans have actually been working on a theory based on analyzing the trading patters of certain very large traders known for their tight relationships with the Kingdom, is that the Saudi’s are aggressively diverting its well documented reserves into #1. Putting significant shorts on Oil Futures and Options, then #2. Announcing that they have no intention of defending the oil price and that they don’t care if it falls to $20, and then get ready to strike with part #3. Take very aggressive long positions in futures and options markets before #4. Announcing that the price has fallen too low and will now support cutting production, preferably one day ahead of a ‘unexpected’ terrorist attack in some strategic oil location. This could fit in well with the Lehigh and Stanford University educated aging Saudi Oil Minister Ali Al-Naimi’s 80th birthday and potential retirement this year.
Major Stock Market Declines Driven by a European Collapse
Normally, lower energy prices would push stock markets higher, but in 2015 we expect the opposite to unfold. In the case of the US, the many years of money printing have pushed stock prices to unrealistic levels, and as such they are very vulnerable to a significant correction that will in all probability be triggered by a collapse in European stocks. Although the politicians and central bankers have done all they could to artificially maintain the illusion that Europe is a viable economic entity, it has been a hospital case since 2008. However, the reality is that with neutral to negative demographics, European wealth creation has gone backwards with an increasing number of members like Greece, Spain, Italy and now France who are all close to bankruptcy. As such, Europe’s dead man walking status will end with a collapse of the stock market in 2015 that will drag the US with it. Whilst a collapse in European stocks can come at any time going forward, the real threat to a break down in the EU can only take place politically. In this context historically there is one thing that kills an electorates’ support of its politicians, and that is deflation. Why? Because, although living costs decrease, assets’ values decline which in a world of credit will have damaging consequences for leveraged borrowers as their equity shrinks. Consequently, we should expect to see political parties that advocate leaving the EU coming to power in Europe in the deflationary phase ahead. Thus, the Euro will continue to be highly vulnerable to depreciation in 2015 of up to 50%.
With such a negative scenario for the Euro some expect it to lead the move and have a horrible year. Any business with revenues in Euros and costs in another currency need to consider hedging asap. Some very smart people I follow expect a depreciation against the dollar in 2015 of up to 50%.
The Dollar has seen a major rally over the past months against a weak to collapsing Euro and weak Yen. Meanwhile Dollar rally will be hurting the trillions of dollars of loans that have been funded in dollars to the emerging markets. Hedging and a reversal of these cash flows will cause the EM currencies to fall relative to the Dollar.
Turmoil in the stock markets has traditionally created a dollar rally as a safe haven currency. This coupled with the relatively strong US economy (thanks to the FED’s printing illusion) suggests that the Dollar will continue to have a good year. However, we view this potential move to sell at some stage dollar assets when the crisis reaches its zenith. At long term the US does not have a viable economy.
Commodity currencies will also continue to suffer in this deflationary phase.
Normally, deflation will drive bond prices higher, but that process has been happening for many years now and may be discounted to large extent. Instead, the big issue will be, can a government repay its debt? As such, nations with negative growth will see considerable declines in the price of bonds, and even those with a healthy balance sheet may well suffer a price decline. Gold With the expedited turmoil in markets we expect hold to be one of the few clear beneficiaries as a store of value which could rise to the $3000 dollars level.
See attached PDF for further reading, but the chart below says it all.
The sharp fall in oil prices will provide a welcome boost to growth in the majority of emerging economies in 2015, but at the cost of slower growth in much of the Middle East and deepening crises in a handful of EMs, notably Russia and Venezuela. The net result is likely to be that aggregate EM growth is broadly unchanged from last year.
The big winners from low oil prices will be those EMs that are large importers of energy. This covers much of the emerging world, including most economies in Asia and Central Europe, but also Turkey, South Africa and Brazil. (See Chart 1 of Emerging Markets Outlook PDF attached.) These economies will see an improvement in their terms of trade as a result of falling oil prices, which in turn will provide support to domestic demand. For Turkey, South Africa and, in particular, India, lower oil prices will also help to ease concern over large current account deficits.
The pain from lower oil prices will be concentrated in EMs that are large energy exporters. (See Chart 2. of Emerging Markets Outlook PDF attached). Most of these are well placed to withstand a fall in oil revenues. The Gulf economies ran large surpluses and accumulated foreign assets when oil prices were high, which will help to cushion the blow now prices have fallen back. In Mexico, lower oil prices will be counterbalanced by a continued recovery in the US and should not prevent growth picking up in 2015. There are exceptions though. The economic consequences for Russia of the collapse in the ruble in the final weeks of last year will become clear over the coming months. We expect a deep recession this year. Venezuela and several economies in West Africa, including Angola, are in trouble too.
Growth in Emerging Asia (excluding China) is likely to accelerate over the next couple of years. Most countries in the region will benefit from lower global oil prices through an improvement in their terms of trade. Lower oil prices will also help keep inflation low, which will allow monetary policy to remain loose. This should all come against a backdrop of gradual export recovery
Now to Peter Schiff’s 2015 predictions (do keep in mind what he does for a living) – "Never walk into a barber and say …. Do you think I need a haircut ?" I do however always appreciate his frank talk and his understanding of the global picture.
Here is a link to his latest video
The part that catches my attention – and whilst he is always selling his gold idea – the man is no fool, far from it.
"Remember, this phony recovery that the Fed has constructed is built on a foundation of quantitative easing and 0% interest rates. If quantitative easing is over, and the Fed is going to raise interest rates, then the foundation is gone and the recovery that rested on top of it is going to collapse. Because of quantitative easing and 0% interest rates, stock prices went up, the real estate market [went up], real estate prices went up and the recovery was built on the wealth effect associated with rising asset prices and the extra leverage that rising asset prices permitted so that we can have more consumption and more speculation. But also, one of the unintended consequences of QE was that other prices went up, like oil prices. Well, as it turns out, oil prices are now the first to fall at the end of QE and at the hint of rate hikes, but they are not going to be the last.
You are going to see falling stock prices, falling real estate prices and the economy returning to recession as the bloom comes off this recovery rose, [and] as stock markets and the real estate market follow the oil market. If you look at all the economic data that has come out since we got the GDP report on the third quarter, it has all been terrible – below estimates, very weak. We are looking at the fourth quarter GDP at best in the low twos, but it might even come in below two, in the ones. If you see this rapid deceleration of the US economy from 5% GDP to barely two or in the ones, there is no way that Fed is going to be raising interest rates."
But then again, as usual, there are several major players out there saying that all is great. (DB – House View 2015 attached also)
And Scott Minerd the CIO at Guggenheim states: " The economic data, though, suggest that these fears are largely unfounded. U.S. growth appears insulated from the slowdown in other countries thus far, evidenced by the U.S. economy growing at 5 percent in the third quarter of 2014—its quickest pace in 11 years. Unfortunately, U.S. equity and credit markets were not safe from the risk aversion that drove volatility during the second half of the year. The global macroeconomic picture is changing, and investors must guard against vulnerabilities. One of those vulnerabilities has been plunging oil prices, which dims the outlook for the energy sector and has caused spread widening across investment-grade and high-yield U.S. fixed-income assets. While we believe risk of defaults in energy is limited in the near term, now is the time to monitor significant exposures that may cause underperformance in potentially worst-case scenarios.
I attached his January 2015 outlook – its normally the one worth printing and taking home to read on a train, doctors waiting room, etc:
“Recent price action in the market is telling us something important. It is betraying that we potentially have something darker and more sinister on our hands. If things play out as I suspect, interest rates and oil prices may head lower in the near term.” – Scott Minerd, Chairman of Investments and Global Chief Investment Officer at Guggenheim
And in closing, here are some further articles that might add perspective to this topic:
I hope you found these ideas useful and thought provoking. I hope you like my new disclaimer below.
Kind regards, Anric
Disclaimer: All characters and events contained herein are entirely fictional. Even those things that appear based on real people and actual events are products of the author’s imagination. Any similarity is merely coincidental. The numbers are unreliable. The statistics too. Consequently, this message does not contain any investment recommendation, advice, or solicitation of any sort for any product, fund or service. The views expressed are strictly those of the author, even if often times they are not actually views held by the author, or directly contradict those views genuinely held by the author. And the views may certainly differ from those of any firm or person that the author may advise, socialize with, or otherwise be associated with. Lastly, any inappropriate language, innuendo or dark humor contained herein is not specifically intended to offend the reader. And besides, nothing could possibly be more offensive than the real-life actions of the inept policy makers, corrupt elected leaders and short, paranoid dictators who infest our little planet. Yet we suffer their indignities everyday. Oh yeah, and past performance is not indicative of future returns. Get used to it !!!