Credit Crunch Anniversary and Mega Trends Investing

By: Nadeem_Walayat

The 'official' anniversary of the credit crunch is linked to when the European Central Bank stepped in to provide an unprecedented amount of liquidity by pumping in $130 billion into the European banking system following news of the French bank Paribas freezing three of its hedge funds due to exposure to the US subprime mortgage market as panicking investors had been dumping holdings of mortgage lenders and mortgage backed derivatives and so began the self feeding credit crunch cycle of mortgage backed losses leading to asset price deflation leading to further tightening of the money markets as banks sought to hoard cash, as they lost confidence in their pricing models of the products they were trading with one another, which is more or less where we are today as the derivatives market continues to deleverage.

However the credit crunch was clearly evident much earlier as i warned in the article of 31st July 07 that the credit crisis had been brewing since at least Feb 2007 as increasing distress was observed amongst participants in the the US mortgage backed securities market which was most evidently made clear with the blow up of the two Bear Stearns hedge funds which pointed the way towards the brewing liquidity crisis as financial institutions were increasingly incapable of valuing their US mortgage backed derivatives. The problem was that even though the subprime market was only estimated at $100 billion, the derivatives magnified the exposure to at least $1 trillion, and maybe as high as $3 trillion of bad debt exposure (Credit crunch Special August 07)

Despite reassurances from central bankers that it was business as usual, it was clear to experienced market analysts that a fundamental change in trend had taken place that had strong repercussions for both interest rates and asset prices which at the time contributed towards my interpretation for much lower interest rates in the US and UK and an imminent bursting of the UK housing bubble, as well as a much tougher climate for stock market investing. The stocks sector at most immediate risk was the banking and financial sector , whilst at the time not wanting to take on the legal department of a big UK bank by suggesting a run on a bank was imminent, I did however point the finger as to the risky nature of one bank in particular called Northern Rock a good 3 weeks before it went bust in spectacular style as a consequence of the frozen money markets and the extreme degree to which it financed long-term mortgage loans via short-term money market borrowings.

The original estimated losses of $200 billion have continued to mushroom higher, where the the estimate of losses keeps doubling every few months, from $200 billion, to $400 billion to $800 billion and now most recently $1600 billion. How high will the actual losses be ? Well that is clearly not something that can be accurately estimated as we have yet to pass the worst point of the credit crisis which will be felt amidst the recession and continue afterwards as it may take at least another 5 years for the banks to work through the bulk of the bad debts.

Key requirements for an end to the crisis is for the US housing market to stabalise, which the most recent data suggests is not happening yet. However the US central bank and government having thrown the moral hazard rule book into the dustbin many months ago are embarked on a programme of ever escalating bailouts to bring to a halt to the slide in US house prices so as to unfreeze the ongoing chain reaction of loss of confidence in the financial system, the price of which has been the loss of value of the US Dollar. This whilst being achievable as eventually the hundreds of billions if not trillion plus wracked up as bailout debt will have the effect of arresting the housing market slump, however the price for which will be a depressed housing market and economy for many more years than if the US housing market had been allowed to complete its market correction.

The implications are that central banks across the globe are adopting similar money printing bailout strategies of accumulating ever larger amounts of government debt via record breaking budget deficits. The surge in government debt will undoubtedly impact on the bond markets as it is inflationary and implies stagflation which is being confirmed by recent economic statistics. Therefore in this climate even after the coming recession, economic growth and average 'real' corporate earnings are likely to underperform. As the deflation of cheap chinese goods, and cheap global food and even more importantly cheap energy are long gone.

This is going to make the next 10 years and beyond a much tougher investment climate, where it is going to be increasingly difficult for investors to generate a return in real-terms i.e. beyond the rate of inflation.

Emerging Markets Mega Trend Investing - The poor earnings climate will therefore require key long-term strategies of focusing investments in sectors and countries that will continue to benefit from the long-term mega trends of the commodity and energy bull markets, as well as the transfer of wealth from the western world to the BRIC emerging markets, especially those countries such as Russia and Brazil which are resource rich. The stock markets are correcting from overbought states in these countries, which in China's case had risen to a Mad near Lunatic pricing level, as i warned of last October, but the subsequent declines to below 3,000 enroute towards 2500 on the SSEC are perking my interest with a view to long-term accumulation. Russia has for several years now been my favored long-term investment of all of the emerging market as I consider it is where China was 10 years ago with the added bonus of immense natural resources, therefore the sell off in sympathy to the global economic slowdown and asset price revaluations gives another opportunity to accumulate for the long-run.

Though its not all gloom and doom for those in the West as savers have been presented with golden opportunities to fix cash savings at high interest rates well beyond the base interest rates as cash starved banks seek to get as much cash walk in through their high street branch doors. For instance in the UK there exist a number of fixed savings products paying between 7% and 7.2% per annum fixed for upto 3years, this in a climate where the UK base rate is at 5%, more than 2% lower. Add to this the increasing probability of deep UK interest rate cuts as the UK economy falls off the edge of a cliff, towards a recession during 2009, implies that UK rates will start to be cut either in advance of or following the release of quarter 3 GDP figures this year.

Surging Inflation is a red herring as the analysis of March 08 warned that the rise in inflation would prove temporary and stagflation would give way to deflation towards the end of this year which would be preceded by a peak in commodities across the board to be followed by a correction that would last as long as 2 years. if anything this outlook has been reinforced by subsequent events as the credit crisis continues to go from bad to worse and commodity markets such as Crude OIl are giving clear signals that a top is in, despite wishful thinking on part of a large section of the media that seeks imminent black swan events such as an US or Israeli attack on Iranian nuclear facilities.

Despite this we remain in a secular commodities bull market that will resume after a deep correction and that will hit some commodities harder than others which if nothing else will give long-term investors an opportunity to accumulate for the long-run as short-term speculators switch directions therefore driving commodity prices sharply lower in a short space of time, which implies increased volatility and much hair pulling amongst short-term investors. Therefore if your not prepared to hold for the long-term i.e. over 5 years then you probably should not be in the market right now or looking to invest, in which case best stick to cash.

By Nadeem Walayat
http://www.marketoracle.co.uk

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Nadeem Walayat has over 20 years experience of trading, analysing and forecasting the financial markets, including one of few who both anticipated and Beat the 1987 Crash. Nadeem is the Editor of The Market Oracle, a FREE Daily Financial Markets Analysis & Forecasting online publication. We present in-depth analysis from over 150 experienced analysts on a range of views of the probable direction of the financial markets. Thus enabling our readers to arrive at an informed opinion on future market direction. http://www.marketoracle.co.uk

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