- Q: How do you read the events as they have unfolded in the past fortnight? How do you think this might shape up?
A: Basically as you know, the US market went up until July 16. The Dow peaked out on July 17 above 14,000 and then it started to slide, mainly driven by financial stocks and by what people call a crisis in the subprime lending sector and the CDO and the BS markets. The question obviously is where do we go from here? Is it like 1998, where we dropped first and then recovered strongly towards the end of the year or is it something more serious? I think it's something more serious.
Q: What’s your prognosis? You think this subprime situation will become worse or do you think these are just indicative of deeper problems in the US economy, which are manifesting themselves?
A: It’s a symptom of excessive credit growth that was obviously encouraged by the US Fed. They pursued extremely expansionary monitory policies before the year 2000, when they bailed out LTCM and then ahead of Y2K that boosted the NASDAQ between January and March 2000 another 30%. And then obviously by slashing the Fed fund rate from 6.5% to 1% and leaving it at 1% for an extended period of time and then as a Fed Chairman, also encouraging people to take out variable mortgages and applauding the subprime lending industry - that has to be said very clearly.
I think the Fed now has obviously stepped in. They bought mortgage-backed securities on last Friday. The ECB has also stepped in, but you create another problem by doing that. You don’t let the market kind of clear and so I suppose what we will eventually get, is more inflation and higher interest rates.
Q: You're saying that the Dow has reasonable chance of plunging below 13,000, or well below that?
A: We went up on the Dow in October 2002, when the Dow was around 7,600, to 14,000. This February in the correction we were at 12,000 on the Dow. The S&P has risen to a high of 1,555 on July 16. We are now down a 100-points.
I think it's not so much a question about how vulnerable the market is, but what is the upside potential. I think the upside potential is extremely limited and I would advise people to actually sell their shares on a rebound. We’re modestly oversold at the present times, some stocks are more oversold than others. Goldman Sachs is down 20% from its peak in a very brief period of time. So there will be bounces, but I would use the bounces as a selling opportunity and not think that this is just the correction in a rising market.
Q: If you did sell out, where would you park your money as there is some opinion suggesting that maybe in this seesaw, Asia and emerging markets will stand at the upper end, while the rest of the developed universe will probably struggle for a bit?
A: That I disagree with, because over the last 3-4 years, a lot of overseas foreign money has flowed into emerging economies and if you compare the performance of Dow Jones to that of the Indian market, then the Indian market is up five times since 2003. So lot of markets are very over extended. When you have a credit cycle of liquidity that turns down and this is a credit super cycle that now has run into some problems along with the process of de-leveraging. In such an environment you don’t what to be an emerging economy.
The outlook for the economies may be favourable, but the outlook for liquidity in emerging stock markets is not very favourable. Starting summer 2005, the housing stocks in the US start to break down and the optimist said don’t worry. Then starting summer of 2006, the subprime lenders started to break down and the optimist said don’t worry, it wont have an impact on the economy. This year, we have a break down of brokerage companies and financial stocks and it's like a domino effect that goes from one sector of the economy to another.
Q: So is it unlikely that equity markets from the emerging space will make new highs for themselves this year?
A: There is always the possibility that some market makes a new high. If I had to make a bet about the market that will make a new high, I would think that the gold market has a chance to make a new high. Because if the Fed cuts interest rates aggressively, in an extreme case, they would go from 5.25% on the Fed fund rate down to 3%. Then people will really become concerned about future inflation and the value of paper money and that will boost gold prices.
But right now my sense is that the best is to hold cash. Now the question is what kind of cash? People have been very negative about the dollar but I have noticed over the last two weeks, the dollar has actually began to perform better against the emerging market currencies - against the New Zealand dollar against the Australian dollar, it’s been weaker against the yen, but the US dollar is okay. Because if a foreign investor sells emerging stock markets, they convert the fund into US dollar and that should be supportive of the US dollar.
Q: You advised many hedge funds. Do you sense that the whole universe is running into a bit of trouble and hedge fund managers are looking to pare down exposure to emerging markets?
A: During the period 2002 to 2006, we had an increase in leverage. To perform you just built up your positions, financed with credits and now we have the process of de-leveraging. In other words, positions are being cut by the proprietary trading departments of banks, by hedge funds and by the insurance industry. And don’t forget a lot of family offices have behaved like hedge funds, they have also huge leverage positions and the funds are funds anyway.
So in this environment there is a general contraction of outstanding debts, the credit contraction is not good for asset markets.
Q: If you had to predict - since your view is bearish, what percentage fall would you expect in emerging market equities over the next foreseeable period?
A: The S&P has a very good chance to decline by 20-30% and the emerging economy stock markets could drop by 40%. That may not mean that the bull market in emerging market is over for good, because in 1987 we had drops in Taiwan of 50% and then the market went up another four times, so you can have a big correction and still be in the bull market.
But if some one came to me and said what is the upside on the S&P? We had 1,452 where the high was 1,555. I would say the upside and the big resistance in the market is between 1,520 and 1,530 so the upside is limited. But what about the risk?
What I noticed is investors are far more concerned about missing the next leg in the bull market on the upside, than about the risk of losing a lot of money. And I think, gradually this will change and that would mean lower equity prices and also prices of other assets such as commodities can go down substantially and obviously home prices around the world.
Source of article: http://www.moneycontrol.com/india/news/fii-view/a-lotemsover-extended-marc-faber/12/49/297874
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