from DeatCatsBouncing

..great article..great analysis..great source..

Recession is spreading faster than Bird Flu…

We have reached a disturbing moment in financial markets, where the noise to signal ratio across all asset classes is probably at an all time high, the August effect notwithstanding. Never has it been more important to adopt a strategic mindset to investing, rather than stampeding after the latest momentum trade without a shred of conviction. I’ve been a skeptic on economic decoupling, and had bet the right way on the dramatic reversal in the dollar (where I strongly suspect we saw discreet US intervention last week, possibly as a quid pro quo to the Gulf States/Saudi for maintaining their dollar pegs after recent visits by Hank Paulson). I’d advised a short on oil and other commodities, where the deteriorating outlook triggered a sudden slump, but I fear that equity markets are still dangerously complacent as to the risk of the brakes slamming on global growth. We will probably reach a tipping point in the next couple of months when the grim outlook for 2009 becomes inescapable and triggers steep earnings downgrades for non-financials and potentially a market panic. I predicted months ago that Japan and much of the Eurozone would be in recession by year end, and that China would see growth slump to mid-high single digits; these views are now becoming consensus. Countries from Estonia to Denmark are now officially in recession, while Spain, Italy, the UK and Canada are a one way bet. Overall, growth is slowing faster and more widely that I had feared, making recent IMF global growth forecasts of 3.9% in 2009 (down from 5% in 2007) look wildly optimistic. I’d take half that and be grateful. Deflation will be the new buzzword before long. The debate as to whether the US is technically in recession using NBER criteria is sterile (I believe one effectively began 6-8 months ago); the key is that recent GDP numbers have stayed positive only thanks to net exports, and exports will now come under pressure as emerging market investment spending slows. Meanwhile, we are at the beginning of a structural downshift in US consumption; personal consumption as a % of GDP reached over 71% in recent years driven by equity withdrawal from housing, against an average from 1975-2000 of 67%; expect at least a reversion to that mean. Policymakers are running out of options; only 10-20% of the recent tax rebate checks were spent, the Fed balance sheet is stretched to its regulatory limit and full of toxic credit sludge swapped by investment banks who are then recycling those Treasuries to feed the leverage appetite of their critically profitable hedge fund clients. The Fed has become the biggest Prime Broker in the world by default. Subsidising overconsumption and overtrading just make the core US economic imbalances worse; ultimately, I’d expect a new ‘New Deal’ involving huge infrastructure/energy diversification spending and $1trn plus deficits to fund it. Having sucessfully traded extreme oversold conditions in financials since mid July, capital preservation will be the priority in the next few months. I will be closing out all my equity positions in into what’s left of the Bear Rally, and buying deep out of the money equity index puts (options are surprisingly cheap given the low VIX), as an insurance policy. If I had to stay invested, consumer staples and healthcare should outperform further. A near term Bull Trap rally in commodities is likely, before the reality of slumping demand in 2009 sees the move I’ve forecast to about half peak levels for most. Agricultural commodities are an exception, having already corrected up to 40% and with structural demand underestimated (see Food: What’s the Chinese for Big Mac?). It is quite possible that incoming housing data will flatter to deceive on the upside, as foreclosure criteria have been relaxed by many banks under regulatory and political pressure, but I’m concerned that the Superprime mortgage market is the next blowup as white collar job losses grow. I’m no Gold fan as regular readers will know, and recent technical damage to the bull case is brutal, but at around $800 those so inclined may well take advantage of the steep selloff to profit from a spike in risk aversion in the Autumn. The wreckage of a real free-fall panic, creating some bargain valuations, will throw up wonderful opportunities for a cash rich investor.