2009: Year of the Ox (And What That Means for the Markets)

'Oxen know they will succeed through hard work and sustained effort and find no truth or benefit in concocting get-rich-quick schemes...' (Chinese Calendar describing the forthcoming Year of the Ox)

Markets are limping exhausted to the end of a tumultuous year but before I look at the likely shape of markets in 2009 and beyond in forthcoming posts, it's crucial to take stock of where we currently are and how we got here. The narrative of the recent market crash and global recession is not as simple as it is often presented. The bad guy in this horror story isn't simply a greedy US consumer splurging on stuff he doesn't need with money he doesn't have. China and the US have been locked in the economic equivalent of a drunken embrace for years, and it was only a matter of time before huge global imbalances in trade and savings were going to revert to a sustainable mean.

The shameless greed of sub-prime mortgage originators and the banks that securitized their loans and parcelled them around the world was fed by a global excess of savings funnelled from the merchandise and energy exporters into Western capital markets, artificially depressing risk premia on assets from emerging market debt to mortgage securities. That excess liquidity, bloated by reckless central bank policy after the Dotcom crash and 9/11, was like financial helium, and ultimately generated simultaneous, overlapping bubbles across several asset classes. Throw in historic lows in volatility, sprinkle with lax regulation and simmer gently for a few years until you smell burning money.

I think two key policy mistakes in 2008 hugely exacerbated the scale of the inevitable crisis. The first was ignoring the wild speculative bubble in commodities and allowing it to grow to such a destructive extreme rather than choking it off with increased margin/regulatory requirements. The second was killing off Lehman Brothers (LEHMQ.PK), causing systemic meltdown that accelerated the downturn in the global economy. Both policy failures were driven by ideological dogma; the market's always right and rational, except it manifestly isn't. One of the drunks has now collapsed to his knees in exhaustion, but China is still staggering and about to keel over without the US to lean on.

In 2008, recognizing where the consensus was most clearly exhibiting crowd psychology was an easy path to profits, whether shorting 'supercycle' commodities or 'decoupled' emerging market equities from the spring, or US equities in the autumn. I had a very good contrarian year, and if I have regrets it is in underestimating the scale of the risk aversion bubble in Treasuries and also being somewhat premature in calling a fundamental bottom in energy recently, as the market remains obsessed with demand destruction while ignoring medium term non-OPEC supply destruction in terms of shelved investment and rising geopolitical risks of instability in key producers.

Although most measures of market risk aversion have been retracing steadily in recent weeks, there is no question that the current deleveraging process will take several years to play out fully both for financial institutions and economies at large, and governments can at best make that process as orderly as possible rather than attempting to sustain the economically unsustainable, from US household consumption and consumer leverage to China's export growth.

At this point the important thing is to ask the right questions. I note that Russian state media are loudly airing the views of ex KGB political scientist Igor Panarin, who foresees civil war and breakup for the US in 2010; maybe he should look closer to home for social collapse. Like the recent extension of the Presidential term to 6 years, levels of anti-American propaganda not seen since Stalin's day reflect the paranoia of Putin's Kremlin as the Russian economy and Rouble collapse after years of rampant corruption and incompetence and civil unrest grows.

On 11 August, I wrote regarding the Georgian invasion:

It all smacks of reckless hubris. A commodity crash would have dire implications for the dysfunctional Russian economy, beset by demographic decline, low productivity, 15% inflation and a fragile consumer boom that is vulnerable to a reversal in commodity export prices...Russia is still a Potemkin village that flatters to deceive. In particular, the Kremlin is not the monolithic power it appears, but referees a shifting coalition of clans, from energy barons to the security services and regional bureaucrats, whose sometimes violent rivalries have so far remained misunderstood by many naive foreign observers.

Watch Russia become increasingly unstable in 2009.

Will we see de facto trade wars develop, as merchandise exporters such as China and Germany refuse to reflate their domestic economies sufficiently? It's ominous that the European and Chinese central banks are clearly so behind the curve and playing the blame game. Will a renewed dollar slump be precipitated by a Treasury funding crisis? Or will the dollar benefit from the US being first to stagger out of recession within a year? Will China see growth slump to near zero? Will the fight against deflation ignite medium term inflation and make assets like TIPS a bargain? Are we on the verge of a shooting war between nuclear armed India and Pakistan?

Lots of questions, so few answers...yet. But stay posted, because I'm thinking about it. I suggest you do the same.

Comments

[socrateazz:]

HMM you think the commodity bubbles were the cause of the problems of today.... I say they were a symptom of the earlier problems. Many dating into the mid 1990's. I think your solution would at best delay the problem, maybe even make the final problem worse. I dislike Marxism for reasons those in control have no clue as to how their basically selfish decisions will affect non target groups. But I think a dose of Marxism is needed because I think the real problem is a wealth distribution problem. So much of the worlds wealth has accumulated in the hands of a few. Adding more cash to The system will help if it does not end up in the hands of those who are accumulating more wealth. I doubt the current policies will help. Most Marxists are no better than rob Peter (capitalists) so Paul (the non producer) has more. I do not think The Producers or Service providers should be blamed for the current situation. The problem is in wealth ending up in dead end hands. I know folk are willing to lend the money. But non-the-less if the borrowers situation is deteriorating as has been happening for a long time, then the borrowed wealth just requires a continuation or an abrupt cut off of loans. The need is for a redistribution of some kind. I doubt a Socialist would find the right balance to stimulate the economy and still treat those with wealth fairly. If the middle class keeps sliping into lower wealth levels the world we have seen since WWII will be gone for an extended time. Injecting capital into a system that accumulates that wealth in few nonproducing hands will ultimately just lower the wealth of all. You are right to ask questions and the need to ask the right questions. Do not assume what appears as answers is really the answer.

2008 Dec 30 08:45 AM

[blisterchicken:]

Greedy Loan Originators? Originators were selling what the banks the programs the banks created.

Kinda like calling a Yugo Salesman a poor engineer.

As far as shooting wars. Well, Israel has got to chill out. I don't have a full grasp of the conflict over there, but I'm going to assume Stephen Speilburg does. If anyone saw Munich, it looks like his opinion is that Israel isn't acting very Jewish, and he basically blames their escalated revenge for the increased extremism in terrorism.

Notice oil go up a bit when Israel started to attack Gaza?

And it's a pretty brutal policy they have. It's not like they are attacking hardened military targets like Saddams Bunkers in Iraq. They are blasting the crap out of slum neighborhoods. And yes, I know they are going after Hamas, but it seems to me if they backed off, and started treating the Palistinians like humans, maybe even started feeding them...it would deflate the Hamas & eventually end their terror.

Terror attacks in Iraq have decreased because the current commander understands this.

As far as a worldwide economic crisis. Well, we were sold the idea that downsizing was good, and that porting all of our manufacturing jobs to a communist country with virtual slaze labor was a good trade off for profits.

I predicted this was unsustainable and dangerous. Germany was uch more technically advance that the allies were in WW2, but the USA being a huge industrialized society just out built the Nazi war machine. Does a Sherman Tank hold a candle to a Panzer? Not a chance. But to 3 Shermans out gun a PAnzer...Damn right...(And OK, we had Patton and Eisenhower).

As far as needing more Marxism...well, in my opinion, the liberal use of Marxism is what has got us in this situation, ie my above example of porting away jobs to a communist counrty. It has sucked the middle class dry, and the short sighted captains of industry are loosing the subjects within their realm whom to sell their goods.

Now proper regulation is needed in several industries. Mainly the media! We have a Mediocracy in America now. Did you notice that the FCC regulations were passed, THEN NAFTA was shoved down out throats. They got rid of most of the dissenting opinion by making the media a big conglomerate tool for corporate adgenda driven greed. It's the huge corporations that are greedy, not some originator who sits in an office making phone calls all day.

The corporations have the rights of a person in court. So if you every go up against one, you are going against a multiheaded monster. Likewise when botton line profit is the ONLY focus of a corporation, what do we end up with...run away greed.

We need to figure out a way where companies are accountable to their local, and global communites in regards to ethics and human rights. Sounds a little hippy dippy, but in fact this is already somehting that is starting with many corpoations.

2008 Dec 30 10:22 AM

[Jason Rines...:]

1) The article is spot on. Geopolitical risk should be factored into investors thought process at this point. Your thoughts on China reflected my own in 2007. I informed the other management we would shorten our acquisition horizen of our company from 2010 to spring of 2008, stating that after Bejiing Olympics and Presidential election the current U.S. economic model of Efficient Market would crumble. Unfortunately, June oil price and major market tremors killed the acquisition. Oh well, guess I will have to learn to eat some 'bitterness' and apply the Chinese Oxen strategy. Timing is so much of everything.

2) Disagree with Marxism Socreatazz.

3) Disagree about Israel Blisterchicken. Israel should have annihalated the Palestinian leadership to nothing after they declared 'Infitada' when Camp David fell apart. Palestinians would have received almost every concession they asked for, showing that Arafat was only interested in himself, not his people.

4) What we saw over the last decade was Feudalism form of government. However, our Republic does work the corrupt will be voted out as pain mounts. Even the lamestream media cannot cover for government as a 'tool'. As mentioned the middle class are getting slaughtered. Check history, that's the stuff of Revolutions. In our American case, that happens with voter revolutions. I believe in my countrymen.

2008 Dec 30 11:03 AM

[Gtarras:]

nice, bulls eye description of the russian environment.. Mr. Poranin u are referring to is just a screw in the propaganda machine launched by the Putin regime.. USA and USA policies are the centerpiece of the machine, and it ricks of the old style theme: we are the fortress with enemies encircling the country..

It is all done in order to create an external enemy and unite country people around whom? thats right.. Mr .Putin...

the dire predictions of the USA civil unrest are simply laughable.. But it makes a good piece of news for the sensationalist reporters in America... yea, they need to sell their papers...

2008 Dec 30 05:31 PM

[Erick Tippett:]

Mr. Maher,

I think the free market system gets left holding the bag and is the fall
guy in this entire economic obscenity! To begin with you appear to be
of the opinion, if I understand you correctly, that the 'free market' is a
part of the problem. Did it ever occur to you that since the inception
of the central banking system here in the United States in 1913, there
has been no true free market to correct anything because of the inter-
ference in its natural cycles by the Federal Reserve Board and it chair-
men dabbling and dibbling with interest rate levels? One of the great-
est tragedies of economic history was the selling of his soul (ideals) by
Allan Greenspan, an astute protagonist of the Austrian Economic School
of thought and student of Ayn Rand the comtemporary of Ludwig Von
Mises, to the dark side of the Keynesian inflationists in order to be in with
the 'power folks' the ones running everything for better and more often
than not, for worse! I've seen this at work all my adult life in all fields!
I saw it when Pearl Bailey and others testified with their own mouths how
they put up with specious manipulations or else in her own words, "they
wouldn't have let me have a career" and then sunk her down into her
chest for what seemed like an hour though it was only a few seconds.
Yes, this is the underlying cancer in american society that so much of
our american public accepts; those unwritten laws enforced behind the
scences and closed curtains, hidden from the light of truth and integrity!
"That's life", "you gotta give the people what they want". Look at what
that philosphy of life has wrought in this country and the world. Central
banking is a european concept, but it was worshiped by American Aristocrats such as Alexander Hamilton, what wanted the United States
to be an imitation Great Britain with an elected Monarch immune from
any form of censure, un-impeachable, and 'elected' to a life term. Mr.
Hamilton the slave-owner believed that debt was good and stiumulative
for an economy and was the main force in establishing the first national
bank of the United States, the cause of economic woes from its inception
until Andrew Jackson dissolved it in defiance of the Supreme Court, un-
fortunately.

I agree with some of your commentary and the comments of others as
well on this article. However, let me say this, the Russian propaganda
concerning the demise of the United States is not laughable and there-
in lies the danger, many think it is! I see a disturbing use of the term
republic thrown around quite a bit in this society. Unfortunately, we have
inherited in this country an educational system said by some to have
sunk to a rank of 25th amongst those of the world. Perhaps this is the reason many do not understand that a difference exists between the terms democracy and republic. According to some historians, the found-
ers of this country's framing documents abhored democracy as 'mob rule'. The word democracy does not exist in any of those documents! In fact, Mr. Washington's general staff offered to storm congress and make him emperor of America! (This may well have been after the Whiskey Rebellion). Was this ever presented to you in any of your history classes? Certainly not in mine! You see, according to Webster both democracy and republic provide for direct or indirect representation of the people with one point of difference; a republic provides for an elected chief of state instead of a monarch! (Mr. Hamilton loved that!) Franklin Roosevelt was able to seize gold during the second world war and fine or imprison anyone violating his 'executive order'. Yet even he went to congress for a declaration of war only after Japan attacked this country at Pearl Harbor. Mr. Bush apparently, felt no legal obligation to do any such thing in initiating his invasion of Iraq on the shaky grounds upon which he did so!

"Our repbulic does work"? "The corrupt will be voted out"? As long as a
brainwashed american public continues to flop from the left to the right
wing of the "republicrat" party system and refuses to listen to the educa-
tional and enlightening offerings of our third party candidates, the same
obscene story with be repeated until total collapse and chaos do result!
The Russians are not too crazy about the United States and never have
been! Unfortunately, the present administration with its 'pax americana'
by force in Iraq and on Russia's fragile borders hasn't helped the rela-
tionship much, now has it? More military personnel and equipment in
foreign countries around the world than the Roman empire at its height!
Whose paying for all of this insane egoism, the american tax payer?
Sooner or later somebody will really get angry and somebody is going to get hurt, like big time! Maybe it is time for a real revolution as the final act of the scenario initiated by the american aristocrats when they rebelled against and replaced the British Aristocracy-Monarchy so they could in turn rule over the american populace by manipulation and a fiat currency system doomed to collapse sooner or later!

Perhaps Adolph Hitler was right when he said "it is a wonderful thing for governments that people don't think!" Perhaps George Santyana was
also right when he said "the people that do not learn from their history
are doomed to repeat it!"

Your suggestion to think about these things is quite appropriate, I do that
all the time, all the time!

EDT
Chicago, Illinois

2008 Dec 31 05:19 AM

[Erick Tippett:]

In checking over my comments I found two typos I want to clear up
1) Alexander Hamilton, who ..... and 2) the same obscene story will
be repeated...

EDT
Chicago, Illinois

2008 Dec 31 05:25 PM