David Roche
Yes, who becomes global president – because that’s what the US leader is – is now to be determined by whether a chad is a chad and thus a legitimate vote for the president, or is merely a tear in the paper and so a spoiled vote.
The sense of unease is palpable. Americans are not used to political instability. For them, this is beginning to feel like a real constitutional crisis. But that’s an exaggeration. For us in Europe, a constitutional crisis means the beat of tank tracks in the streets. A change of prime minister in Italy is as insignificant as a stray dog’s marker at the lamp post of power.
My own reading of US politics is different from that of the bears. The media tell us to be stressed because the country is split. Rubbish. The country is united in being unable to distinguish between two stunningly mediocre candidates for the world’s leading job. The net result is that whoever gets in will have to fight for the heart and soul of America’s middle ground. The first thing any president will have to do is to heal the non-existent rift in society by espousing the more moderate policies of the other party. The same goes for the slim Republican majority in the Senate and the slightly bigger one in the House.
That cuts out a lot of extremism. Indeed, the real danger of extremism would have been a Democrat win in Congress propelling people like Dick Gephardt as Speaker and his pro-labour, anti-business colleagues into real power. No matter who becomes president, that worst-case outcome has been eschewed.
The budget surpluses will still be around and used to pay down debt – to the good of global interest rates and the cost of capital. Both candidates represented a big risk in that respect. But with the need to conquer the middle ground, combined with only a tiny majority for the Republicans in the Senate, you can wave goodbye to Bush’s tax cuts or Gore’s big spending plans. Many conservative Republicans, voting along conviction rather than party lines, will simply not support even a Republican president’s wilder initiatives.
To a very great extent, the old checks and balances will continue to operate to the benefit of investors.
The fallout from the current US presidential dead heat will help slow the economy but it won’t make things so bad as to create a full-blown recession. It will just speed and confirm a soft landing. Indeed, the “return of inflation” outcome, which would have been the harbinger of the big bear market, is made more unlikely by the loss of confidence of Americans in themselves that the rest of us are now witnessing with some measure of wonder.
My guess is that beyond the fetid mists hanging over this slough of despond, the sun will shine. It would take a combination of slowing growth and rising inflation to put the real squeeze on markets. That would send discount rates up and what’s being discounted down. The result would be a compression of asset duration like Woody Woodpecker’s beak in a frontal collision with a wall. But accelerating core inflation (that’s excluding oil) has not raised its ugly head. I don’t think it will.
If anything, the economic risks in the world are on the side of the ice age rather than in the hell of inflationary fire. Underneath the panic about oil prices, inflation is not accelerating. Bond markets around the world are telling us as much. Global growth will come down from 4%-plus to less than 3% as oil costs, falling asset prices and the higher interest rates decreed by the world’s conservative central bankers all take their toll. By the end of the first quarter of next year, those same central bankers that hiked interest rates over the last year will be cutting them.
And oil will be $25 per barrel or less by May next year. The flithy war of religious extremism in the Middle East will spread thin veins of photo-op atrocities to other countries and continue to grab headlines. But it will not stop Opec pumping more oil. The biggest risk to this vision is not Iraq, which needs to keep producing, even if its mustachioed dictator mouths otherwise, but that Opec fails to produce up to the new quotas and Saudi Arabia finds it difficult to increase production again for fear of appearing to be Uncle Sam’s lackey.
The market will take a while to adjust to lower growth in earnings. So this mini-bear market will feel like a big bear market for a little longer. But a revival of structural inflation won’t happen. The competitive impact of the new economy will take care of that. That makes this period of volatility and correction in equity markets a time to buy and not to sell.
Up to now, I’ve been long the S&P500 or Dow – as symbols of the old economy that will benefit most from the new – and short Nasdaq. But that call has run its course. From now, I’d be building up positions in both old and new economy stocks. US stocks are still the world’s most attractive. Also, the dire state of many emerging markets, the potential for a government bond crisis in Japan and the eurozone’s lack of credibility mean that foreigners’ appetite for dollar assets will remain strong.
If I am wrong and there is a global crisis, it would start with a loss of confidence by US consumers. The liabilities of US households have been rising fast, at over 10% a year. And margin debt (borrowing to buy equities) has been at record levels.
At the same time, the corporate sector is now more dependent on capital markets for funds than is comfortable. And US banks have sinking financial ratios. They mouth off about tightening policy, but they have not stopped lending.
If several big new economy stocks suddenly went under, it would draw attention to the relative weakness of the financial sector’s capital ratios. Credit contraction would ensue and equity markets would fall 30%. That would wipe out a big enough slice of consumer net worth to cause demand deflation.
The fall guy would be Europe. If the US economy fell into deflation, Europe would collapse into stagnation as growth evaporated but inflation did not. The euro would not be seen as a safe haven in a global deflationary crisis because of the fiscal fallout and political ramifications.stagnation reduces tax revenues, increases unemployment and social security costs and raises the cost of debt to governments. The EU’s stability pact and the Emu’s Maastricht criteria would be shot to pieces.
The long-term membership of the euro of such countries as Italy, Portugal and Greece would be called into question by markets, and bond yield diffentials would explode. Unreformed, big-state France would not look pretty either. If Germany decided to foot the bill for the weaker states, the euro would get weaker, making stagnation even worse.
And globally, the biggest casualty of this bear market would be the increase in risk appetite I foresee. Sure, the central bankers would deliver falling short-term interest rates, but only because the world was collapsing.
But I put the chances of this Armageddon outcome panning out at no more than 25%. I’m keeping the faith and staying bullish.
