Financial Fears Sweeping the Globe

As rocky as the global markets have been, the worst is yet to come, the Royal Bank of Scotland Group PLC (RBS) warns.

RBS analysts have warned clients to brace for a full-blown crash in the global stock-and-bond markets over the next three months as the conflicting realities of slowing growth and rising inflation paralyze the world’s major central banks - causing “all the chickens [to] come home to roost,” Great Britain’s Daily Telegraph newspaper reported.

The report, which first surfaced late Wednesday, raced across the Internet yesterday (Thursday), though it appears that European news organizations are giving it much wider play than their U.S. counterparts.

The predicted swoon would cause the U.S. Standard & Poor’s 500 Index - already down 15% from its trading high of 1,576.09 reached Oct. 11 - to nosedive all the way down to 1,050 by September. For the closely watched, broad-based U.S. stock index, that would represent an additional decline of 22% from yesterday’s close of 1,342.83 - and a total decline of 33% from its Oct. 11 apex.

This is the worst forecast of any investment bank survey followed by Bloomberg News.

“The Europeans, in general, tend to have much-more conservative banking systems and financial vehicles than we have here in the United States,” said Keith Fitz-Gerald, investment director for Money Morning. “They’ve been through centuries of economic and financial conflict. For that reason, they are much more pre-conditioned and predisposed to listen to major warnings like this one.”

The sell-off that RBS expects to deepen started last fall after the U.S. subprime-mortgage crisis turned into a full-blown credit debacle even as it took on a worldwide reach. Banks and brokerages have written off roughly $400 billion in assets. But that torrent of write-downs may get even worse: At a conference in Monaco yesterday, New York hedge fund manager John Paulson estimated that this amount will triple to $1.3 trillion - a reality that will clearly exacerbate the decline of the financial markets worldwide, Bloomberg reported.

The predicted “contagion” will spread across Europe and will afflict the emerging markets, including the fast-growing economies in Asia, the RBS research team wrote to clients in a June 11 report. RBS is Britain’s second-largest bank.

A sell-off of that breadth and magnitude would represent one of the worst bear markets the world has seen over the last century, and would clearly have implications reaching beyond stock-and-bond prices.

“A very nasty period is soon to be upon us - be prepared,” said Bob Janjuah, 42, a U.K-based credit strategist for RBS.

In the credit markets, high-grade corporate bonds would see their trading values soar, while their lower-grade counterparts would see their own values plunge, thanks to a “renewed bout of panic on the [global] debt markets,” the Daily Telegraph reported, citing key excerpts of the internal RBS report.

Addressing the fallout that RBS expects to see in the bond markets, Janjuah wrote to clients that he couldn’t “be much blunter. If you have to be in credit, focus on quality, short durations [and] non-cyclical defensive names.”

The credit analyst - who became an industry star after his grim warnings about the current global credit crisis played out as he predicted - also counseled clients that “cash is the key safe haven. This is about not losing your money, and not losing your job.”

RBS expects the U.S. stock market to rally into the early part of July, thanks chiefly to the boosts provided by the aggressive rate-cutting campaign that the U.S. Federal Reserve launched last September and from the tax-rebate checks that were initiated by the Bush Administration’s economic-stimulus plan. Those benefits will soon sputter and the real damage from soaring food-and-energy prices will finally become apparent.

Unfortunately, the world’s leading central banks may not be in the position to help out this time around. In fact, both the Fed and the European Central Bank (ECB) face a so-called “Hobson’s choice” as workers start losing their jobs en masse and lenders continue to cut off credit, the Daily Telegraph said.

Usually, the central banks would just cut interest rates or employ some other form of monetary stimulus to help their economies regain positive momentum. That’s not an option this time around: The soaring food-and-energy prices are already pushing inflationary pressures to levels that will destabilize stock-and-bond markets.

The bottom line is that the U.S. economy could end up with stagflation, the rare but hard-to-eradicate one-two punch of high unemployment and high inflation.

“The ugly spoiler is that we may need to see much lower global growth in order to get lower inflation,” Janjuah said. “The Fed is in panic mode. The massive credibility chasms down which the Fed and maybe even the ECB will plummet when they fail to hike rates in the face of higher inflation will combine to give us a big sell-off in risky assets.”

And Europe won’t dodge the bullet, RBS debt-markets chief Kit Jukes said.

“Economic weakness is spreading and the latest data on consumer demand and confidence are dire,” Jukes told the newspaper. “The ECB is hell-bent on raising rates. The political fall-out could be substantial as finance ministers from the weaker economies rail at the ECB.”

 ”What is being discussed here is absolutely within the realm of possibility and is a possibility that we’ve been discussing here in Money Morning for quite some time, now,” Fitz-Gerald, the Money Morning investment director, said in the interview yesterday. “And we’ve never wavered in that conviction. In situations like this one, the best offense is a good defense, which consists of an appropriately structured and diversified portfolio of holdings that emphasize stability and balance, and current income derived from global markets. That kind of portfolio may well weather this kind of storm much better than a U.S.-based portfolio in isolation.

“This report - and others like it - may be extremely unsettling to individual investors. But the historical record is unequivocally clear that the best profit opportunities come when everyone thinks the skies are darkest. Savvy investors at this point in time can take steps to help them avoid this even if the rest of the world sinks into an economic cataclysm.”

Comments

[Eagle-Chief]

No comments? No comments? Maybe your story was just posted a few minutes ago, Sir William.
Thanks for covering a subject which many news sources avoid like the plague. I hope this doesn't turn out to be the "mother of all meltdowns," such as a worldwide depression. Your second paragragh (the RBS warning) is quite scary to think about. Such a crisis or crash could make the Great Depression seem like a stroll in the park.

[gabeborenstein]

Amazing,in June of 2005 I have predicted the current turmoil in an interview with Mark Gilbert(Bloomberg-Lond... I recall events correctly ,my opinion was ignored(but not by my clients).On September 18 of 2007 ,I have reiterated the warning about the financial debacle to follow as a result of the subprime related issues about to surface.That opinion was met with the great degree of skepticism.On several occasions I have used the word Armageddon in order to describe the financial events to follow-that was met with a degree of skeptisism. As of now ,I am quite sure that the worst case scenario had been averted and the financial markets are heading for a brighter future.The catalytic FED's intervention during the J.P Morgan-Bear "merger" had signalled that the FED will not allow a financial failure.In fact it allowed financial institutions to swap a "subprime"pa... for the treasuries .That is an expression of confidence.In the meantime ,the financial institutions for practical purposes ,had written of most of the potentially risky exposure.The FED had eased aggressively in order to facilitate economic rebound (allow for the lag).The rebate program initiated by President Bush will provide a relevant fiscal stimulus.Finally , the cheap dollar(J-Curve) will expand the export sector almost geometrically (please allow for the lag).In fact the prospects for the U.S look quite brite -unless you are in contact with doom sayers with the positions to back it up.In fact the economic chaos /implosion ,poses the greatest risk to the Emerging Economies and Europe. The leverage utilized in the emerging countries is at the record . In Europe the high(higher )rates ,will cause a dramtic pullback in consumer spending.For all of the nonsense about the European conservatism,it should be quite clear that Europe is facing same problems as the U.S ,but their institutions did not address all of the issues as we did in U.S . In fact the next Armageddon to followc ,could implode the European and the Emerging market economies.Psychology molded by the media is not the constructive reality that the U.S is facing in the period ahead.It is precisely the risks outside the U.S that will cause massive inflows into dollar denominated assets(U.S),causing unprecedented (pehaps illogical) stock market rally in the period ahead.For all of the market hysteria(reinforced by the media),I believe that the Dow is heading for 20,000and the NASDAQ should reach at least 6000.

[GrapeApe]

Wow. 20,000??!! Even with a raging bull market it should take years to get to that number from 12K.

All I can really say to that is I disagree.

[blah-blah]

Articles like this and the recent capitulation in the banks are great contrarian indicators. Almost everyone universally thinks the financials are going to zero.

[iThinkBig]

I am with you GrapeApe on time it takes to grow Dow to 20,000. Nasdaq will probably fare a lot better then the Dow for the next couple of years. I predicted the market crash in June 2007. So what? I predict a financial collapse in 2010. Plenty of data to support financial pain following market pain. This time, both are very deeply intertwined, like a 1987 scenerio but on a much bigger scale. Same thing as 29'. The true financial pain takes a couple of years to reveal the true nature of it's ugly head. But this time is different Gabe Bornestein? I challenge you to explain why.

Good call on the the credit crisis but was easier to figure out based on bloated real-estate asset. Much harder to figure out real losses of the deravatives and alt-a problems and that in and of itself is beyond troubling. The Dow is indeed headed for 20,000. In the year 2030, see I am a seer too.

[CLH]

All of you UNDER THE BED. Gabe and I will continue to stand in the sun unafraid.

[PIA]

Invest, Diversify, and be Patient. A globally diversified portfolio with appropriate liquidity to endure downturns and buy as valuations present themselves should be a savers and investors focus.

Attempting to Predict Market Index downturns and upturns with precision in amounts and timing is a game for those who continually lift their oars out and in the water and never get very far.

Forget spending valuable time and effort attempting to predict the unpredictable.

Exercise a proven Process and Approach while doing your homework on companies/industries/t... to sustain your portfolio through the unpredictable yet inevitable market turns.

Time "IN-vested" prevails over "Timing Markets" given that you get and stay invested in a high quality diversified portfolio of global equities while maintaining adequate liquid reserves to endure downturns and provide for cash to "invest" when the bear raises its unpredictable head offering great opportunities for long-term investors.

[Will Rahal]

In the US most analysts are claiming that "the worse is over" Investors who believed that we are bouncing at the bottom of the economic cycle , pushed the market higher.
There is little doubt about the consumer slowing.
The business sector (reflected by the NASDQ out performance) is still holding up.

[SWRichmond]

I am not under any beds. I am merely standing under a different sun. We will see who gets a nice tan and who gets burned.

I eagerly search the internet and elsewhere for someone who can explain to me how $400 Billion in Fed money and $300 Billion in stimulus checks is going to counterbalance $1 Trillion in subprime write downs, another few hundred $Billion in Alt-A (coming), an estimated $2 Trillion of lending that will not occur since the banks are broke (look at nonborrowed reserves if you don't believe me).

Someone please show me where the money is going to come from. Please. I'll change my allocations on Monday. SHOW ME THE MONEY.

[algoa456]

Sometime over the next month Time magazine will feature the coming melt down on its cover. So will the Economist. That will mark the end of the crisis and the start of the next bull market.

Things are not good, but they are NOT the end of the world. And this being an election year the media is keen to talk down the economy as much as possible to get the Banana into the White House.

Think I am crazy - check LexisNexis: during Bush senior's tenure reports on homeless people skyrocketed reaching a crescendo just before the election. Soon as Clinton got in those stories went away.

This time they have something to build on so they are having a field day.

[SWRichmond]

algoa, you are right about the election cycle and the media. I also believe that at our level, you and I will never have access to accurate information about anything.

Having said that, all I can do is make decisions based on the information I have. The stupid republicans talk up the economy for their purposes just as much as the stupid democrats talk it down for theirs.

Look at the USDX since 2001. Look at the price of gold since 2001. There is absolutely no political will in the US to deal with ANY real fiscal issues. We borrow and spend, and defer payment by printing. Where is the $50 Trillion to pay for SS and Medicare going to come from? There is no money, and there is no will to do what is necessary to get it. Printing is just too easy.

The SWF's have been burned and won't be back until the discounts are "real". Show me where the money is going to come from. Real money, not ink on paper. Real money produced the old fashioned way: by producing goods and services that can be sold in foreign exchange, made right here in the USA by real Americans. We can make stuff while 20- or 30-to-one leverage is unwinding.

Show me where that money is going to come from. PLease.

[bruin532]

If your a buy and hold investor this is not like the 2001 fall that was derived on fear. This is all on techical data thats stacked to the roof. Its tough selling and watching 10-15% given back when you thought it was in the bank. The thunder clouds are rolling in you've been warned if you get wet or worse struck my lightening I hope you've got the time horizon to wait this one out!

[Prognostic]

Wow, nice article and an outstanding contrarian thinking response by Gabe B.

I think the outcome lies inbetween these two very different outlooks. I would almost agree with Gabe but for one variable -- high energy prices. I believe high energy prices to be a destructive phenomenon. If the back of oil is broken I am more likely to agree with Gabe's scenario. However, if oil continues to rise and then something unthinkable happens (such as a full blown conflict between Iran and Israel) then the RBS scenario seems more likely.

[gabeborenstein]

At least we have heated and intelligent dialogue going.All said and done ,I will not argue with the responses as they all have their merits.. I claim the following ,the greatest financial risks will eminate from the Emerging market economies(record leverage and dependance on the U.S economy) and Europe(basically facing same issues as U.S but unwilling to face them ).We will see economic implosion in the those economic zones contributing to a massive (record)demand for the dollar assets .This demand will partially translate into unprecedented stock market rally .The point? the mega stock market rally lies ahead even if for the wrong reasons.

[SWRichmond]

Gabe,

Yes, either that, or a massive repudiation of paper financial assets regardless of issuer. Your position is that money will seek US assets as a "safe gaven", and in recent history that has been true. I think the debt / fiscal overhang in the US is too great this time, and more importantly it is widely recognized as such. If Eurozone unravels I will be buying whatever the new DM is, but I will still be fleeing dollars. The Germans have had their fill of inflation and know what a sound currnecy is. Interestingly, they also know how to make stuff that sells abroad. What a concept.

Oil is behaving like a currency right now. Oil's runup represents a loss of faith in paper, especially in US paper. It has widely recognized international value going forward, in contrast to paper assets which will all be suspect until the accountants stop lying and the real writedowns are revealed. Accounting is supposed to be about knowing what you have, and proving it by showing it to everyone. Now it is about hiding what you don't have.

Oil is real. Food is real. So are other commodities, and that explains their price performance, which is measured in suspect paper. The more suspicious the paper, the more paper it takes to get something real. This will continue until faith in paper returns.

[rsusich]

One cannot determine how much additional writeoffs by the financials is still to come. If Paulson is correct, the Dow averages will drop 300-500 points.

[gabeborenstein]

SW,possible alternative outcome that sounds like a Weimer Republic.I would like the FED in conjunction with the relevant exchanges to impose 100% margins on commodities traded on COMEX ,Nymex and possibly CBOT.There is no doubt in my mind that a commodity price implosion will follow. Back in 1980 ,with the inflation rampaging at 18% ,the trading universe maintained the perspective as you have just reflected .A famous Texan,Bunker Hunt, started buyng silver .Silver had spiked to 50 dollars an oz and the gold had exceeded 800 dollars an oz.For several reasons COMEX had raised the margin rates to 100% of the contract's value.The silver had imploded to 4 dollars an oz and the gold under 300 dollars an oz.Over period of time the inflation had declined to 3%.Let's try this remedy now as Weimer Republic alternative equals an economic Armageddon.

[SWRichmond]

Gabe,

Does changing the rules in the middle of the game affect the outcome? Certainly. Does this provide investors with a stable environment for decision making? Certainly not. But I agree that incremental margin raises are on the way. Politicians who otherwise talk a good game about free market economics won't hesitate a second to clamp down on money to make it flow back into stocks "where it belongs".

The problem is, the US no longer houses all the exchanges anymore, and with US IB's all but dead our hegemony over money flows ain't what it used to be. And if we dare to show the world that our "free" markets are very much un-free then where is all that capital inflow you look for going to come from?

"Invest in the US and then they'll change the rules to save their own assess." Yeah, that's a clarion call for overseas investment if I ever heard one.

[User 88243]

The situation now is much wors, than in 2000, at least the same.
I agree with your statement 100%.
**********************...
There are no investors out, buying stocks the next 6 month, only
traders. Means, more sellers, than buyers, that s for shure.
The China bottom is predicted for Q1 2009, so goes DOW and
S&P, as you predicted.
European stocks have a - 30% downside until years end.

Buy "only" FXP and you will make huge money.
I do not see any catalysts on the horizon, but black birds.

DOW below 11 750 will lead us to 10 000 , latest in 2009.
Compare with 200/2001.
The CNBC chart analyst is right.

[moonbat1775]

There once was a mouse in a maze. The maze was rather big and the mouse was clever. He made good progress in it and was quite happy until he discovered the maze had no exits.

[moonbat1775]

Speaking of 100% margin requirements, how about 100% reserve requirements? Or is that too honest? One more boom/bust cycle may result in another world war if history is any guide. How odd that people think a financial system built on a dishonest banking system can be stable. The wealth achieved via gaming a corrupt system may be lost anyway if the economic destruction leads to more socialism.

Jefferson said something about a nation of "stockjobbers&quo... What a waste of time, energy, and talent.

[Bruce B.Lawrence]

The jump in foreclosures is just beginning. When the multitude of resets begin in October, look for keys to come flying into loan servicers. The best place to be for continued employment will be in loss mitigation, residential home security, asset recovery/disposition and foreclosure/trustee services. Wonder now how all of this problem was caused by the twenty-three year old "mortgage brokers" at New Century or did they have help from some of the wizzards of Wall Street?

[ATHELSTAN]

Perhaps, the time has come for Bush to seize all national banks and their assets , in effect making the Fed our National Bank. Next, Bush needs to close the gold window, and for the Treasury Dept. to start selling gold.
Could the Federal Reserve or the Paulson gang be any worse than the clowns in the private banking universe who endangered the economies of the planet with their willingness to play monkey see, monkey do? And their allies in the U.S. financial media acting as if they too are monkeys. I see no evil. I hear no evil. I speak no evil.
Thanks to the failings of our private institutions, Bush and Bernanke will have no choice but to literally throw money at America's home owners in the form of a housing stimulus package, or see family wealth continue to erode. Thus igniting deflation on top of slowing demand.
Raising interest rates in Europe, or in the US is an act of suicide!!

Best to initiated this stimulus package before the depression starts and not during the early stages of it.