The 'R' word is everywhere. It's being discussed at World Economic Forum at Davos and now we have clients calling in at Orpheus, asking us about "recession" and how bad it is. And, is there a chance that the global depression might be starting? Such worries, though, important and critical, do highlight the mass psychology and how it reads the Federal interest rate cut and subprime crisis as a start of something bigger and problematic.
First and foremost, recession is not an event, it's a process. It happens again and again. And, when the recession lasts for more than three successive quarters of negative growth and prolongs, we call it a depression. We have had one depression in the US and one in Japan from 1929-1932 and 1980-1993, respectively.
A part of the market sees this as a sectoral crisis, just in the financial sector. But, crisis is never sectoral, it's always linked to credit and is across market. This is why a financial crisis is also called a confidence crisis. As liquidity dries, the counterparties panic and everyone wants to move out at the same time. This is the reason one-time write-downs might not be enough.
Markets need confidence more than write-downs. It's like saying if the Fed cuts the benchmark again, things will be fine. Some might however, look at it differently i.e. if the Fed cuts it again, we have a more serious problem. In any case, a Fed cut does little to boost confidence, the most needed commodity today. Markets follow their own rhythm; no wonder the S&P 500 has rallied, on the same day as a Fed rate cut, only six of the last 13 times. And, if all this was not enough, we have Alan Greenspan doubting Fed's ability to avert a recession, everybody seems ready.
But, the recession or great depression does not start till we have these negative quarters. All we are doing now is anticipating. And, even if we are anticipating, are we not a bit too late? The housing crisis started more than a year earlier and has already pushed prices substantially lower. We have more than a million foreclosures.
The Philadelphia housing index has dropped by 60 per cent from 2005 high and sales of new houses are at 25 year low. Even the subprime has seen a lot of wealth erosion. The overall economic loss is estimated at $2.3 trillion. The third indicator, considered as the most reliable predictor of US slow down, is the S&P 500, which is still negative for the last seven years, as it failed yet again when it reached previous 2000 highs.
This suggests that the slow down, what we talk about today, is already under play for the last few years, and that is why anticipating a recession is different from what is happening.
Robert Prechter, market thinker, compared Dow Jones with gold and proved that the slowdown is already happening with the Dow Jones falling 67 per cent compared to gold, over the last eight years. This, he calls,
as the silent crash. We have mentioned it so many times prior in our write ups, saying that though history repeats itself, it never repeats in the same way.
And, this time the slowdown is happening without people realising how our real purchasing power is eroding. Gold is near the $1,000 mark (per ounce), and some estimates put it at $3,000 by 2013. What would that mean? That would mean that even if markets, locally or globally, don't really crash, the effective value of money will become a fraction of it. And, gold will become the most valuable asset, more valuable than real estate or stocks, as they are all denominated in paper money.
This is already happening, not only in America, but across the world. The real value is shifting to gold, even though we don't realise this. And, we should consider ourselves lucky, if gold gives us a last dip back sub-$600, before starting the next big leg up till 2013.
So, though equities in America and emerging markets might be witnessing a fall in value compared to gold, the relative performance of emerging markets over the last seven years is much better than that in the US. Plus, the level of financial securitisation in America, or leverage, is much higher in the developed world compared to emerging markets. So, even if we may seem to come down together, there is always a relative performance.
And, the adjustments to US slowdown are dynamic and happening all the time. Over the last eight years, the US dollar has depreciated 87.5 per cent against the Euro. The slowdown is already taking a toll on the purchasing power parity of Americans. So, markets around the world cannot be really clubbed together with looming asteroid and recessions, we do need to factor in local relative currency strengthening also.
The talk of a crisis is a mass psychology creation. And, even if we leave the gold peg behind, the correlations between global and local markets is an overplay of statistics. What works is only the short-term correlations in contagions, other correlations are weak and flawed predictability indicators. The world will not come to an end even if the US plays down, as adjustments are happening consistently.
In conclusion, we don't believe anticipating recession can bring over a more serious chaos than what is already happening. Rather we think the mass psychology element highlights an in-built positivity to the whole thing. We in emerging markets are still low on critical mass to get seriously burnt with any global slowdown. And, the real crisis may still be months away. And, even if the worst comes earlier, we can laugh about these terms like the late US President (Ronald) Reagan did, when he said, "A recession is when your neighbour loses his job, a depression is when you lose yours."
The writer is CEO, Orpheus Capitals, a global alternative research company.