According to the author of the article, the world is on the verge of a disastrous recession that is being led by slowing global growth, economic shocks, failed expectations as well as many other factors.
January 4, 2012
Yoni Jacobs - Chart Prophet
Seeking Alpha
2012 will be a decisive year for stock markets and economies worldwide. After a huge recession in 2007-2009, followed by a sharp “recovery” until May 2011, we now find ourselves at a major juncture that may reveal the fate of stocks and economies for the next decade.
It seems that almost the entire world is stuck in three camps with different outlooks as to what the future brings: one group thinks the worst is over and that the economy will continue to recover, the second group thinks we had a temporary recovery but that we are now entering a double-dip recession, and the third group (perhaps those who are too uncertain or afraid to make a directional call) thinks the economy will muddle through directionless and flat for some time. All of these scenarios are still possible, but I favor scenario #2 – that we are on the verge of a disastrous recession led by slowing global growth, economic shocks, the onset of deflation, falling commodity prices, downgrades and failed expectations.
Since it is still possible that the worst is over and that we may be approaching a major bull market, investors who decide to short the market must be extremely cautious and hedged in case the bearish thesis is proven wrong (keep an eye on the May 2011 highs and the October 2007 all-time highs). At the same time, those investors who truly believe the economy is on track for a full recovery must also be extremely cautious and hedged in case of a sharp recession, flash crash or major volatility. Making a directional bet without protecting your portfolio is foolish.
In order to accurately present our bearish thesis for 2012, I will present you with the themes to watch over the course of the next 6-12 months. These investment themes and events will reveal much information about the future viability or failure of global stock markets and economies, and may be the major deciding factors of our future.
Emerging Markets
The collapse of the emerging markets, especially China, India, and Brazil, will have a huge ripple effect on the rest of the world’s economies, and will plunge most countries back into a global recession.
It is our view that emerging market growth has reached an unsustainable level and that a slowdown is taking place. A slowdown is generally not such a calamitous situation, but with expectations for China, and emerging markets at such extremes, the failure to meet or beat these lofty forecasts could mean big shocks to global economies and stocks.
Our reasons for severely doubting the continuation of the emerging markets theme stem from a long list of dangerous warning signs.
Emerging Market Warning Signs
- Surging inflation that threatens sustainable growth
- Soaring money supply that fuels bubbles in stocks and real estate
- Credit bubbles
- Massive and understated loan exposure
- Tightening monetary policy that could “put the brakes” on the economy
- Inverted yield curves that usually appear before recessions
- Real estate bubbles evident in ghost towns and empty malls
- Overconfidence buying at auctions
- The infamous “skyscraper indicator”
- Fraudulent companies that have attracted investment from around the world when they are nothing but “shell” companies with unproven financials
- Most importantly: The stock markets of China, Brazil, and others have been deep into bear-market territory in 2011 – down between 20 percent and 30 percent from their peaks
The problems continue to surface – from slowdown in manufacturing (visible in the PMI of Brazil, and China, which point to economic contraction), to slowing economic growth (shown in GDP and inflation), to mass speculation gone wrong (seen with major failures in the Chinese high-speed rail, fraudulent companies, real estate bubbles), and most notably – failing stock markets, which tend to lead the economy by a few months to a year.
Since we believe emerging markets are the key to the fate of global economies, investing in or against countries like China, Brazil, and India, may prove to be the most profitable bets over the next year or two. That said, investors looking for emerging market exposure should look at China (FXI), Brazil (EWZ), or broad emerging markets (EEM). On the other hand, investors who see the ongoing trouble and potential upcoming catastrophe in these markets may look to short China (FXP) or triple-short emerging markets (EDZ). Our favorite play at this time is EDZ, as we expect emerging markets to fall sharply as investors begin to realize and accept a worldwide recession. As always, however, a purely directional bet must be hedged and protected; those who are long emerging markets should protect their portfolios through some short exposure (FXP, EDZ, or put options), while those who are short should protect their portfolios through some long exposure (buying stocks of favorite companies or call options).
European Crisis
Perhaps one of the largest threats to the global economy, Europe’s tremendous instability could ensure a global economic catastrophe. Similar to Lehman Brothers’ role in triggering or exacerbating the financial meltdown of 2008, Greece’s massive financial troubles may drag all of Europe into a domino-like economic collapse. Since many of the European countries are economically tied to each other through the euro, the financial collapse of any eurozone country could severely impact all the other countries. And with the eurozone countries attempting to stop the contagion by bailing out the failing countries, they could be dragged into the financial mess themselves.
Greece is in no way the only problem. Italy, Spain, Portugal, Ireland, and others are all at huge risk of collapsing and dragging the rest of the world into their mess. Unemployment levels have reached over 20 percent in some countries, with youth unemployment nearly double that. The strongest countries, Germany, and France, have been greatly impacted by the massive financial upheavals – having already entered bear markets, as their stock markets have been down approximately 30 percent from their peaks. Europe’s leaders, together with central banks, have attempted to fix these disastrous conditions; but unless the contagion can be contained and limited to Greece, we can expect financial meltdown in “snowball” fashion to ensue – as collapse and default spreads from country to country, dragging financially responsible countries like Germany into the mess created by Greece, Italy, Spain, and others.
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