Friday, July 27, 2007

Gloom or Doom for Global Markets?

Here's a worth reading interview:

Classic Business Day gets investment guru Dr. Marc Faber on the line to find out what we can expect in the world markets. Faber is well know as author of “The Gloom, Boom and Doom Report” and his current bestseller is “Tomorrow’s Gold”

LINDSAY WILLIAMS: If you’d been watching Bloomberg Television a couple of weeks ago you’d have noticed a chap called Marc Faber the internationally renowned investment guru. Is he a guru? I don’t know. Anyway, he is very well known indeed. He was talking about bubbles on Bloomberg. I tracked him down on Thursday night in a hotel room in Chicago, and I asked him about bubbles - I started off by asking him what the background to what he perceives as the present bubble environment to be?

MARC FABER: I think that to go back to 2002 we had after 2001 ultra-expansion monetary policies in the U.S. that led to strong consumption growth, but at the same time to a growing trade and current account deficit. Basically the current account deficit has grown from 2% of GDP in the U.S. in 1999 to currently close to 8% of GDP that throws $800 billion into the world, and has led to asset inflation across the board. In other words since 2002 everything has gone up - stocks, commodities, real estate, art prices, and even bond prices have been rising. The question is of course that at the end of a major bubble the leadership narrows and one sector after another no longer participates. Now what we have in the world starting in 2005 is developing weakness in the U.S. housing market, and with housing stocks peaking out in 2005 that was followed by a peak in the sub-prime lending industry in the U.S., and as you know after June 2006 sub-prime lenders began to decline and then collapse at the end of 2006 and in early 2007. More recently we had weakness across the board in financial stocks - especially U.S. brokerage stocks - and I think that one bubble after the other is therefore deflating whereby at the end the one or the other bubble can become gigantic. We have a huge increase in the value of emerging economies, we still have strong increases in energy prices and that may go on for a while - but overall I think that for the global economy and especially the U.S. economy if you have a situation where credit growth drives assets prices, which in turn drives economic activity - then credit growth has to continuously accelerate to maintain the economic plane’s altitude, and the moment credit growth just expands at a static rate or credit growth decelerates then you have a problem in the economy, and I think we’ve reached that stage in the U.S.

LINDSAY WILLIAMS: So are we then seeing credit growth in the United States starting to fall out of the equation, in other words there’s not enough credit growth to fuel the asset prices and therefore not enough to fuel economic activity at the current levels?

MARC FABER: Yes, correct. I think we have a situation where the credit growth has slowed down somewhat and will lead to not all asset prices still rising - home prices in the US are no longer going up, and other assets are no longer going up in real terms. If you look at the Dow Jones and the S&P since February measured in euro or measured in gold the S&P hasn’t bettered its February high, also the S&P is up say 8% in U.S. dollar terms but since the beginning of the year in euro terms it’s only up 3% - and in gold terms it is down. So you can print money like the fake stuff and still pursue an expansionary monetary policy - but that doesn’t mean that asset prices across the board will increase in value.

LINDSAY WILLIAMS: That’s a fairly gloomy picture so far painted by Mr Faber. The U.S. housing market has been in decline for quite a while - and when I say in decline some areas are actually falling not just in real terms, but also in absolute terms. I then asked Marc Faber when the U.S. housing slump is finally going to realise its full potential as being a bubble and start to drag down other markets as well. …

MARC FABER: Well it’s become a problem to the extent that the financial stocks are no longer going up - basically year to date financial stocks are down, and in particular financial stocks that have a big exposure to the collateralised debt obligation (CDO) market, because the housing problem hurts people that didn’t have any money and didn’t make any down payments on their homes - and took out sub-prime loans. Now the CDO market is probably about 50% sub-prime, and as you know already two hedge funds blew out completely at Bear Stearns. In my opinion a lot more damage will come from that with some investment banks now having problem in raising money for leveraged buyouts (LBOs) - so I think that the problem of the CDO market with infect other sectors of the credit market. To that extent it has already had an impact - but the market is strong largely because energy stocks are still strong, and here and there one or another stock is taken out in a leveraged buyout, or you have some upside surprises like today in IBM. By and large market leadership particularly in the U.S. has narrowed considerably.

LINDSAY WILLIAMS: The Chinese economy grew 11.9% in the second quarter of 2007 its fastest pace in 12 years. I asked Marc Faber if maybe the Chinese situation could also be a potential bubble. …

MARC FABER: I think that we have probably some excesses in China in terms of capital spending, and eventually the Chinese economy will also slow down. A recession in China would be if their growth slowed down from 11% to 5% or 6% - but we have to realise that China is a very large country, and you could have a recession in one sector or in one region of the country and in other regions and in other sectors of the economy the growth would continue. If you look at recessions in the U.S. over the last 200 years frequently you had a recession - say in Texas when the oil bubble burst in 1980 but the North East did well - or in the early 1990s we had a recession in California and other regions of the U.S. were expanding. So I think that I wouldn’t think that the Chinese bubble is going to be a huge problem. Also, the stock market has gone up a lot - but if you look at cash deposits by individual households in the system then they are over 100% of GDP and the household’s financial assets are only invested to the extent of about 10% in the share market. So yes, I think we have a bubble in China. Is it going to be a devastating bubble? I don’t think so.

LINDSAY WILLIAMS: The subject of art came up as well in our chat. I noticed on a website a couple of days ago that Veuve Cliquot the French champagne house is bringing out a centenary or bi-centenary bottle of champagne - it’s three litres, it’s got a leather label, and it’s $2,000. A normal bottle of Veuve Cliquot goes at around $40 - surely this is a sign that there’s too much money around and things are getting out of hand? I asked Marc Faber if he thought that was the case. …

MARC FABER: Yes, I think you’re touching on a very important issue. If you spend money - and basically in the U.S. since the early 1980s credit growth has vastly exceeded the GDP growth, with the result that credit as a percent of GDP has expanded between 1980 and today from 130% of GDP to over 330% of GDP - if you have this kind of environment then you create a huge wealth and income disparity or inequality, where money shifts from the working class and from the middle class into the hands of what I call the “asset shufflers”. The asset shufflers are the people working on Wall Street - fund managers, hedge fund managers, accountants, lawyers and so forth. These people have done exceedingly well, and as you know in the case of hedge funds huge bonuses are paid out each year - and that has led to the contemporary art market rising by 50% over the last 12 months. Also, you have wine prices going through the roof, the price of collectables going through the roof, Park Avenue apartments, Mayfair apartments, and so forth. So you have a dual economy - the economy of the median household or the typical household in a society, where income and wealth is not increasing in real terms in other words adjusted for inflation - but the rich become unbelievably rich. In 1980 there were just six billionaires in the world - today you have over 1,000 billionaires in the world. It also shows that there is a depreciation in paper money - in other words inflation.

LINDSAY WILLIAMS: What about stock markets, though? It’s all very well talking about art - but for all of us it’s really what happens on the JSE that’s important. The JSE is still bossed a little bit by the U.S. markets - is there a bubble on the U.S. stock market?

MARC FABER: We have a bubble in U.S. stocks maybe - but we have a much bigger bubble in Spanish real estate, we have a much bigger bubble in art prices and in prestigious real estate and collectables than say in U.S. equities - which are at the new all-time high, except for the Nasdaq. If you adjust the Dow Jones and the S&P for the depreciation of the dollar then in euro terms the Dow is still down 35% from its 2000 peak, the S&P by a similar amount, and the Nasdaq in euro terms is still down 63% from peak. In gold terms all the U.S. indices are down more than 50% from their peaks. So the U.S. Federal Reserve can print money - in nominal terms they can boost things - but it means the dollar goes down, and certainly goes down against gold.

LINDSAY WILLIAMS: Bubbles can carry on inflating though that’s the problem. I asked Marc Faber when is it all going to come to fruition, and if it does what’s going to happen?

MARC FABER: I think you’re touching on a very important point. That it will happen there’s no question about it at some point. At that point what can the U.S. Fed do? They can print money - and then the dollar crashes and that creates a new set of problems. I would imagine that looking at the performance of assets over the last two years we had housing starting to come down, then we had the sub-prime mess, and recently if you look at the performance of say Merrill Lynch or Goldman Sachs all these stocks are performing very badly, and this is a very negative technical sign. I would imagine that we are right here near the top of the bubble and that we could burst any time. I have turned essentially very bearish right now.