Quarterly Update

Economic Outlook: There is good news and there is bad news


THE BAD NEWS… A BEAR MARKET IS UPON US

Even though the markets are off 20% and look very cheap on an earnings basis, there is still a lot more risk in this market and chances are the trend is still lower over the next several months.  What is significant, this is now an OFFICIAL BEAR MARKET.  It first showed up as a correction this spring in risk assets on the $TSX and other commodities markets.  It has now entered into full blown BEAR territory on all markets.  Since August, there has been no relief with global indices breaking down.  Copper is off more than 30% confirming what many were beginning to fear, that Chinese demand is fading.  This is indicating that that while growth is stalling in North America and recession problems throughout Europe, China the great driver of commodities is stalling at the same time as well.

Even the luster of gold has been lost over the last month and has joined the broad based selling that has crept into all markets.   As panic about the global deleveraging process has taken hold and no more QE in sight over the short term, there is no reason to hold gold at such lofty levels.  Ben has said markets need to get much worse for more QE.  If Ben announced QE measures right now, they would not have the desired effect and would be burning up good money as Euro fears would overshadow everything else.   Even helicopter Ben knows when to pull in the reigns.  Let the bugs that are still in the system get washed out before passing Go and collecting another $600B.

With the deleveraging process putting global markets into a sinkhole, there is no real threat of inflation and deflationary pressures are appearing worldwide putting more imminent pressure to the downside on equities markets.

The Debt Death Spiral

Countries in Europe are dangerously close to entering into the ‘Debt Death Spiral’.  This is a negative feedback loop that compounds debt problems into much bigger problems.  Higher borrowing costs eat into profits which eat into a company’s ability to added value.  In turn this inability to add value creates less confidence which increases borrowing costs and further eats into profits.  Company then makes cuts which further hamper ability to make profit.  Thus further impairment increases borrowing costs and the whole cycle repeats.

The Debt Death Spiral is not happening to companies… it is happening to entire countries!  Greece is the prime example of what will eventually happening to Italy, Spain, Portugal, and maybe even France if Europe does not get its house in order.   If European nations do nothing to act to intervene in this negative feedback cycle… this will be the course that many of these countries may have to take down the road to eventual default.  Tough austerity measures further hasten this cycle as a huge economic void is been create through the deleveraging process.  The public sector needs to be deleveraged, but it cannot be just in itself as this void that is left needs to be filled or deflationary pressures will exist for extended periods even after default.    In order to achieve a smooth balance, leverage needs to be transferred from government to the private sector where it can be managed by professionals, not politicians who promise the sky on the backs of our kids.  The leverage needs to be transferred to the private sector.  

When people talk about the debt crisis being much worse than the subprime crisis, it is this void that is created by the deleveraging process.   This is just a theoretical void… the system will not be allowed to fail, so when markets trade under such stress and fear that the system is falling apart…  you need to step back, have some patience and pick your moments to invest.   Markets will recover and trade much higher than they are now years on out.
At this point in time, in the exploration sector especially, there is real value appearing if you think markets are going to bottom over the next 6 – 12 months. 

The world is not going to end, credit will not seize up, exploration and development companies will still get financed and citizens around the world will still go to work.   Credit may potentially seize up for a moment, but it won’t over an extended period of time.  The world just doesn’t stop turning and neither will its inhabitants drop the tools of the trade and not go work.   The markets are trading on an irrational fear that is made worse from the seemingly arrogance to the nature of the problem by politicians around the world.  It is a fear that is magnified throughout the economy in confidence and spending while this problem exists.  In the end, no matter how divisive and bi-partisan politics get, no one wants the system to come to a crashing halt on their watch so 11 hour deals to patch the problem are always made.

China’s dependence on Europe as a trading partner cannot be overstated.  If Europe goes, China goes.

China’s emerging consumer economy is not strong enough to take the place of European demand.  If Europe fades into recession, it over-exaggerates China’s pause which puts further pressure on global markets.  Copper tanking indicates to me the slowdown in China is going to be harder than originally thought.  Usually when a metal breaks down like this, there is more downside expected.   All signals on China are slightly bearish at best with many analysts starting to call for a harder landing there.  At the very least, China will remain subdued until Europe fixes its problems or the Chinese consumer comes to the rescue.    That will only happen if Europe comes online again or China pursues a policy of wealth creation for their own citizens through dollar appreciation if they feel they have sucked every last dollar they can out of the global economy.

China took us out of recession last time, and it will have the opposite effect if China slows down more than anticipated during this downturn with the deleveraging process going on.  There is no way to tell how far this downturn will go because there is systemic risk at the core of the system for which leaders still cannot agree on a solution.  This amplifies the risk in the system and magnifies the swings in economic data and confidence in the markets and ultimately on a business decision to spend.



7 STEPS FOR EUROPEAN STABILITY
1.       Give Greece the money
2.       Negotiate a Greek default
3.       Capitalize European Banks – Euro Tarp
4.       Protect borrowing costs of peripherals with Euro bonds     
           a.       Buy peripheral debt
           b.      Sell Euro bonds
5.       Duel Pronged Austerity/Growth Package
           a.       Deleverage public sector (austerity)
           b.      Leverage the private sector (stimulus)
6.       Work on economic uniformity to eliminate inequalities
7.       Confidence comes back to Europe

The GOOD NEWS…  

We are now closing in on an influx point where momentum traders and swing traders can make some money!!!

The DOW is bumping up on a key downtrend line initially established in August.  If markets can break this trend line, we could be in for a nice 1000 point rally on the DOW and TSX alike.  Last week’s rally started on a rumor that European officials were talking about a TARP style recapitalization effort of European banks.  If European officials can still confidence that TARP will happen, it will alleviate concerns about the system falling apart over the short term.  TARP is the easiest way to allow for stability in the system.  The US Treasury’s TARP program was initially estimated at greater than $300B in losses, but by the time the markets recovered and banks paid back the interest, the cost to US taxpayers was $25B and Geithner still contest that the cost in the end will be much less once real estate assets in the US have recovered.  That is less than 10% of what was originally estimated.   TARP saved the system once; there is no reason why it wouldn’t perform the same function again in Europe.   TARP was signed in October of 2008, if markets react the same and take the same amount of time for the


 European Banks to access TARP  and work the troubled assets out of the system, you might expect the a 5 or 6 months to really take effect and instill confidences system and for markets to recover.  Certainly at that point you can expect another V like recovering with projects on the shelf come back to construction.  Markets are not done bottoming but you may get some short term relief.




TARP RUMORS CONFIRMED

Merkel and Sarkozy have made a joint statement saying that they have agreed to strengthen the banks by the end of the month.  So far not many details are known, but it now looks like there is a united front for a TARP like program to save the European banks.  If you combine that with a Q3 earnings season next week that should keep yield at the forefront, you have the fundamentals in place for ‘hope and optimism.’   This is an emotionally charged market.  You have to look for what might break the change in sentiment.  This just might be it.  Greece getting the money, a Euro style recapitalization effort, an earnings season that isn’t so bad; might be the basis for a sustained bear rally in all asset classes.

The keystone to this change in sentiment lies in Europe and a concerted effort for a TARP program and eventually a EURO BOND to stop the debt death spiral.  This is fundamental in saving the European banking system and allowing the system to function.

If European banks go under… a double dip is likely.



Read the rest of the article at my site...

Beat the Market Stock Picks: Quarterly Update