Some Scenarios for a Global Recession

Includes: FMCC, FNMA, LEH
by: Paolo Pezzutti

I read these articles published on popular websites. My first feeling was: I need to sell everything I have. How am I going to save my money here? Pessimism is everywhere. Energy and commodities prices are going down. They will continue to do so as the global recession scenario unfolds. Emerging markets will be particularly hit. Equities are in a bear market. Forecasts for equities in some cases are so negative that are really scary also for experienced investors. Bonds should do fine, but are we sure?

Inflation is the new big enemy of this decade according to some analysts. Interest rates can only go higher in the long term, some say (including Greenspan). The US financial system is about to blow up according to someone else. Actually, the Fannie Mae (FNM) and Freedie Mac (FRE) stories and others (Lehman (LEH), Bear Stearns, etc.) are a pretty serious concern. Liquidity is shrinking, consumers are shaken.

The US has so far fueled growth in many areas of the world, becoming a big debtor. In the long term, the trend will continue, but it is likely that it will slow down. It seems that this cannot be sustained much longer and a rebalance has finally started. The US still has an important influence in the global economy. China will suffer a lot from the ongoing US simultaneous crisis in the credit and housing markets. Internal contradictions and the need to grow will create difficulties. This is true for other surplus and emerging countries.

Let's try to build a scenario. The US deficit will be reduced and the dollar will be relatively stronger. Commodity and energy prices will go down, helping to control inflation at least momentarily. I have recently noted a rebound of the stock market associated with a stronger dollar and weaker commodities and energy prices. This correlation should continue.

The US financial system will find a base to stabilize itself, although it will be much weaker than before. Also housing will at last stabilize. The problem is: how quickly will these adjustments occur? At which levels markets will attract new buyers? Do we have any elements to make some assumptions? It is quite difficult to predict. The tightening of credit is not helping and there is a vicious circle ongoing.

Geopolitically, we are seeing a long term growth of new and old regional actors. This is likely to continue. Money will continue to flow from traditional economies to frontier and emerging markets, but slower than before after that the current crisis will have considerably weakened the investors' appetite for these volatile and often unstable markets and countries.

In the short term we have to fear a shock in the markets. An event, although sometimes crashes occur without apparent reasons, that will ignite a global panic selling. No one can now whether this time it will happen or not. Hopefully, inflation will be controlled soon enough to allow central banks to act and lower interest rates timely.

There are and there will be buying opportunities. The timing is quite difficult. The recent rebound of the stock market has not been very convincing. I do not have the evidence, however, to say that the bottom has already been hit in July. I think that the key for a relatively stronger equity market will come from a turnaround of financials. we need to monitor this sector very carefully. Bad news will continue to hit the sector for some time, but this sector's bottom is key to bring some optimism into the markets.

I think that stocks eventually will benefit the most from a stabilization of the economies. Hopefully, the US will manage with the new President to start a path of control of the deficit. This would help a lot. It would also make the dollar stronger. And we could see stock indexes print new highs.

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