Global Recession: What To Invest In?

Includes: DIA, FXE, SPY, UDN, UUP
by: John M. Mason

Guess what? The United States economy is "the brightest spot in the world economy." This assessment comes from the latest Brookings Institution-Financial Times tracking index.

This is with the United States growing at an average rate of about 2.0 percent year-over-year for the past year and with no expected improvement in the near future! In Europe, Portugal, Italy, Greece, and Spain are all expected to experience sharp declines in economic activity "towards the levels of 2008-2009". Growth has even slackened off "in the formerly strong economics such as the Brics (Brazil, Russia, India, and China)."

In Europe there are two major efforts going on to correct the situation. The first effort is to force further fiscal austerity on those countries (especially Greece, Spain, and possibly Italy) facing the most serious budgetary problems. There is, of course, resistance within the countries against such action.

Some analysts are saying that the continued austerity cannot achieve what it is set out to do and that these countries, primarily Greece and Spain, will eventually have to leave the European Union. A second effort is to build a bailout fund, the European Stability Mechanism or ESM, which will eventually accumulate €500 billion to rescue countries or banks within the union.

Right now, however, the nations in the EU are having difficulties completing the package. Questions still remain about how the ESM is going to be implemented and how it will be run. Since most of the funds supporting this effort will be raised in the open market there area questions about whether or not the market will support the issue at reasonable interest rates.

In the United States, questions are being raised about the future of the American economy. Of course, there are the concerns about the "fiscal cliff" to be faced in the government and the implications how the resolution of the "cliff" will be impact economic growth.

Furthermore, it is earnings season in the United States and most forecasts of the third quarter just ended are for earnings to be below what they were one year ago. We read, "Wall Street analysts expect third quarter earnings per share for S&P 500 companies will fall 2.7 percent versus the same quarter a year ago."

As I reported three weeks ago, FedEx (NYSE:FDX) and UPS (NYSE:UPS), two major companies in the transportation sector, cut their earnings projections for the year, citing the slowdown in world trade. The Dow-Jones Transportation Index has been trending downwards since May of this year. Historically, this is not a good sign for the economy.

Central banks in Europe and the United States are flooding the world with liquidity in an effort to stem the economic weakness given the current efforts being made by governments to get their budgets under control. The problem is that these efforts are not going to produce the economic growth the central banks are aiming for. They will just serve as a holding pattern until the real issues that underlie the problems are addressed.

However, I don't see the end to this economic crisis at this time. To me, the real issues are not being addressed. Unfortunately, the real issues will not be addressed for some time because people will have to go through a real change in mindset before they will see the issues clearly.

This means that most of the policies that will be applied to the conditions described above will result in "unintended consequences." That is, there will be investment opportunities that arise from the government policies that will be implemented.

I have not come to this conclusion easily. One thing that has helped me get to this point is reading the interviews with "market wizards" conducted by Jack Schwager. His latest book is titled "Hedge Fund Market Wizards," published by John Wiley, but he has published two other books of interviews with people who have been very successful trading in financial markets.

The stories in these books are not unlike the story of George Soros "braking the Bank of England." As you may remember, this case had to do with the Bank of England attempting to maintain the value of the British Pound within the bands set up in the former Exchange Rate Mechanism before the creation of the euro.

As governments in Europe and the United States attempt to devise policies that attempt to "force" solutions on Europe and America that are inconsistent with the underlying realities that exist, opportunities will be created to make a lot of money.

This is what has happened over the past 50 years or so and, as long as the governments attempt to sustain the same type of policies in the future, more opportunities for financial gain will be created. This is why the income/wealth distribution has become so skewed.

Note that the opportunities to gain financially will be more like the one exploited by Soros. The opportunities will be more like the many examples provided by Schwager in his books. I believe that the environment created by the continual application of credit inflation is one of distortions; distortions that result in a misallocation of resources that will eventually bust. It is an environment that will experience bubbles, which will then revert back to something more fundamental.

My focus in the future is going to be the exploration of these opportunities created by misallocations. In doing this, I am definitely looking for "Alpha" opportunities. The situations in Europe and America … and in the rest of the world…are going to lend themselves to this kind of investing over the near future.

Some of these ideas will have to do with currency movements. For example, the euro/dollar relationship gets a lot of headlines. But, with the central banks of both the United States and Europe both pushing different versions of quantitative easing, whether the euro is strong relative to the dollar or vice versa depends upon who is getting the attention at any particular time.

But, there are other countries that are not playing such silly games. Dollar weakness can be found relative to the currencies of these countries.

Others opportunities will come with respect to the bonds of countries whose governments are playing games with their budgets or their banking regulations. Governments do things for political reasons that don't make sense economically. These are the things we need to look for.

Some of my efforts in the future will be to more specifically identify some of these situations.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.