Marc Faber: Issues and Market Uncertainties
[...] I have tried to overcome my inability to forecast the future by stressing relative values among the various asset markets since in a credit induced asset bubble all assets rise in price but at different rates of appreciation. Nevertheless, I have to admit that in the last few months I have become increasingly apprehensive about how the various asset markets will move as I struggle with the following issues.
It isn't clear to me whether we shall experience more inflation in the years ahead, or whether deflation is still a serious threat. In particular, we must be aware that there is always some relative inflation in some assets or sectors of the economy, and especially so in a monetary system that enables, even frequently encourages, central bankers to print an unlimited quantity of money.
Even under a gold standard, an economy will always have some sectors that are inflating relative to others. As a market observer, it is imperative, therefore, to think about which sectors will relatively inflate compared to others, since this phenomenon of relative inflation can also be observed in periods of serious deflation, as was the case in the last quarter of the 19th century and in the 1930s.
As an example, bond prices and cash inflated relative to the overall price level in the 1930s and in Japan over the last 15 years.
Interestingly enough, the same could be said of commodity prices during the Great Depression. But whether we shall experience an overall increase in prices (the manifestation of inflationary symptoms) or declining prices will depend on an unknown factor and this relates to the quantity of money the American Federal Reserve Board will inject in the system.
Money supply growth has been decelerating since 2001. Further deceleration in the growth of monetary aggregates will lead to even more US dollar strength and poorly performing asset markets (except US treasury bonds), whereas renewed strong money supply growth will bring about what we had over the last two years – rising asset markets accompanied by a weak US dollar!
A second issue that preoccupies my mind relates to the growing imbalances in the world. It would seem to me that the US consumer is the all-time champion at borrowing and spending on consumer goods and irrelevant services, while China is the undisputed champion at spending on capital goods, including structures, and producing goods.
In the meantime, India and, increasingly, Vietnam are emerging as impressive forces in the tradable service sector. How will these imbalances eventually be resolved, and who will emerge from this imbalance-induced collision course relatively better off?
Conventional wisdom, as well as the media with its focus on China's great achievements, a view I tend to endorse, argue for a relative adjustment in favor of China, India, and the other emerging markets. However, could this almost unanimous view, at least temporarily, be erroneous?
After all we should not forget that China has built enormous excess capacities in the manufacturing sector, which could lead when demand disappoints to a hard landing as a result of a significant reduction in the growth rate of capital spending.
Moreover, we should not overlook the fact that periods of decelerating US money supply growth and, especially improving US current account deficits, have in the past led to crises in emerging markets.
An increasing number of economists, myself included, have become more and more concerned about the diverging performance between the financial economy and the real economy.
It is an undisputed fact that the financial economy, which now provides almost 50% of S&P earnings, has been growing (inflating) at a much faster rate than the real economy. Eventually a readjustment is inevitable, but could it be that we all underestimate how much further the financial economy could grow relative to the real economy?
Also, is it possible that this dichotomy between the financial economy and the real economy could be corrected through a significant pick-up in the real economy, as today's central bankers ardently hope? And if the financial economy were, sometime in the future, to badly deflate, could it be that the real economy would also suffer just as badly when the process of eliminating the strongly diverging trends between the two gets going in earnest?
For now, it would appear that some deflationary forces are emerging in the financial sector since numerous financial stocks led by Fannie Mae and followed by sub-prime lenders such as Accredited Home Lenders (LEND), Capital One Financial (COF), and New Home Financial (NEW) have begun to break down (I am short these stocks).
Lately, it has become common wisdom that the incremental demand for commodities coming from China's industrialization will drive commodity prices higher in the longer term.
Again, I find myself leaning on the side of the consensus, which as a contrarian worries me and leads me to think about the possibilities of being wrong. Given my near term positive view of the US dollar, I am out of industrial commodities and focus this year on the accumulation of the grains such as wheat, soybeans and corn.
Lastly, I can't help but consider the likelihood that the world has entered an upturn in geopolitical tensions, which could be the prelude either to unpleasant civil disturbances or, in the worst case, to serious military confrontations and vicious acts of terror.
In addition to rising geopolitical tensions, I am also concerned that recent events surrounding the spread of the bird flu from human to human will, in time, lead to a pandemic of historic proportions.
Therefore, in view of all these uncertainties, the best option for investors might be to maintain low leverage, small positions and bet on some further recovery in the US dollar, which has completed a five wave decline.
Still, the US dollar has quickly rallied by more than 5% against the Euro, and, therefore, a correction should be expected in the near term, which would offer a better USD entry point. In fact, a retest of the US dollar lows and even a marginal new low would not surprise me and would not alter the view that the US dollar is about to enter a recovery phase, which could last longer than the consensus believes.
Since Asian currencies weakened against the Euro over the last two years, as they tracked the US dollar, a lower risk speculation, at least for now, might be to short the Swiss Franc against the Yen rather than to go long the US dollar. |
