Read The Aftershock Investor: A Crash Course in Staying Afloat in a Sinking Economy Online

Authors: David Wiedemer,Robert A. Wiedemer,Cindy S. Spitzer

The Aftershock Investor: A Crash Course in Staying Afloat in a Sinking Economy (8 page)

Iran: Our Next Black Swan?

On almost everyone’s list of potential “black swan” events this year is Iran. We think it is unlikely that the current administration would support bombing Iran’s nuclear facilities in an election year. However, the possibility of an Israeli strike on Iran looms as a real possibility. The reason is that many in the Israeli military and government believe that there is only a limited period of time left to attack those facilities before it is too late. They certainly have said little to dampen discussion of an attack. Given their past successes, they may feel they can pull off a repeat performance.

If such an attack is made, it’s not that relevant to investors whether it is successful or not. Any attack would upset Iran and they will attack back. Any such attacks will naturally drive up the price of oil. Even the threat of such attacks has already driven up the price of oil. Higher oil prices could be just the economic shock the world
doesn’t
need given the fragile state of many of the world’s economies, especially Europe and Japan.

Jim Chanos—A Realistic View of China
There are a few voices out there saying that China’s problems are far greater than most economists and financial analysts realize, most notably hedge fund manager Jim Chanos of Kynikos Fund, which is why we give him an ABE Award for Intellectual Courage (ABE stands for the name of our first book,
America’s Bubble Economy
).
Jim Chanos is the founder and president of Kynikos Associates, a hedge fund with a particular focus on short selling. While the practice of short selling has been somewhat controversial, especially in recent years, one value of companies like Kynikos is that they can point out critical flaws in the market long before most people see them. For example, back in 2000, Kynikos took short positions in a huge energy company, one that
Fortune
had consistently labeled America’s most innovative company. Within the next 14 months, the stock had lost 99 percent of its value and the company ended up in bankruptcy. You’ve probably heard of Enron.
Chanos admits that he’s not a “macro guy.” His focus is intensive fundamental research and analysis to find stocks that are overvalued. But that hasn’t stopped him from seeing some big picture problems, too, and in recent years he has pinpointed a major bubble in the world economy: the Chinese construction bubble.
Chanos noticed several years ago that property development in China was reaching unsustainable proportions. If the average Chinese couple makes a combined $8,000 or so a year, how can they afford condominiums that can easily cost up to $150,000? It didn’t add up. Much of this growth was driven by bad loans pushed by the government. In fact, Chanos found that many new apartment buildings stay empty and are flipped from speculator to speculator on the greater fool theory.
As Chanos explains it, China starts with, ‘We are going to grow 9 percent next year. Now how do we get there?’” Because so much of China’s GDP growth comes from construction, the government needs to push new property development in order to keep the growth going. If construction slows, the whole Chinese economy slows and that will hurt China’s suppliers in Australia, Canada, Germany, and elsewhere (many of which are shorted by Kynikos).
Chanos insights aren’t especially popular in a financial community that’s counting on China to lead the global economic recovery. He has been publicly berated by some, though the attacks against him tend to be very short on data. While he may not be a macro guy, and doesn’t agree with us on everything, he deserves big kudos for ignoring the cheerleaders and letting the facts speak for themselves.

One question is just how long the oil price shock will last. If the United States is able to control any attacks on oil supplies militarily, the impact will be lessened. But if it spirals out of control, then all bets are off. The Libyan uprising had far less impact on oil supplies than an Iran war likely would, and it still had significant long-term impacts last year. Iran could be bigger, with much depending on exactly what happens. No doubt, all financial markets will take a short term hit if there is an attack on Iran. Stocks will be hit. There will likely be a flight to safety that will help bonds and the dollar. Gold will also likely benefit. If there are no other problems in the world economy, there may be a relatively quick recovery. But, if combined with other problems in Europe or a slowdown in the U.S. “recovery,” its effects will be multiplied and longer lasting. It’s certainly the Black Swan du jour and one to keep an eye on.

The Passage of Time

While we tend to focus on possible future dangers that could kick off the coming Aftershock, the most likely trigger will simply be the passage of time. It would be quite wonderful if we really could print all the money we want forever, without ever having to face a single bad consequence. Think of all the problems we could solve, think of all the fun we could have! But such nonsense is the stuff of childhood dreams. Of course, we cannot print money endlessly without a future cost. And, of course, that cost is going to eventually come.

Even if, by some miracle or magic trick, high future inflation is somehow avoided, what about all these bubbles? In what universe do rising bubbles never fall? Sooner or later,
bubbles always pop
. That is why, regardless of what triggers may or may not occur, regardless of what manipulations may be deployed, even regardless of what marginal economic growth we may be able to somehow produce,
time happens
. The passage of time, alone, will be enough to make the colinked multibubble U.S. and world economies eventually burst.

A Closer Look at the Current U.S. “Recovery”

We sometimes put the word “recovery” in quotation marks because it’s not clear just how strong this economic recovery really is. We can easily see the recovery in the stock market, which is enormous. But that’s to be expected. Since the financial crisis, the stock market has always jumped on any signs of green shoots as an excuse to shoot up. The market is also very careful in the numbers it looks at. It closely watches good numbers and focuses less on bad numbers. It also doesn’t look too closely at those good numbers to see how real or accurate they really are.

The Good Doctor
As we have so often said, this is not just America’s Bubble Economy; it is the World’s Bubble Economy. China is an excellent example of this, which brings us to another issue. Some people say that we are anti-American because we talk about America’s Bubble Economy, but we most certainly are not. We try very hard to be
anti-nothing
. We try to be unbiased, although we know that many people say that and are not. But we hope we are. Given our very pointed assertion in
America’s Bubble Economy
and
Aftershock
that the United States will absolutely perform the best after the Aftershock because of the inherent flexibility of its economy and the structure of its economy, which encourages growth and innovation, it seems that would indicate that we are not anti–United States. In addition, we also say that China and its nonmarket, heavily government-controlled economy will do the worst (with Japan doing the next worst and Europe doing the best outside of the United States). We further say that it will be so bad that there will ultimately be a popular revolt against the government (a Tiananmen Square that succeeds) that will move the country to a more democratic state.
The point of this example is that we try not to have any bias, although after reading this, some people would say we are too pro–United States. It’s hard to please everyone, and we certainly do not try. We try to call it as we see it, just as any good doctor should in diagnosing and treating a patient. We strive to be the best and most unbiased economic doctor in the house. Short term, that may anger some people—investors, economists, and financial media members—and it may please others. Long term, we are absolutely sure it is the best, and only, approach to take if we are to truly understand and solve our economic problems.

A good example of the bad numbers they are ignoring right now are corporate earnings. First quarter earnings have not been that good, and companies are not giving good signs that we should be expecting a big improvement ahead.

Another number they ignore is how much Wall Street insider selling there has been. Insider selling in the first quarter of 2012 was the heaviest first quarter in a decade. Insider selling is not always a good reason to doubt the market, but it sure looks bad when it changes so fast and management decides to sell so much. It seems like they aren’t long-term believers in the market.

In addition, stock market volume has been very weak. In a bull market, you would normally like to see big increases on increasing volume, not increases on decreasing volume. That doesn’t indicate a lot of conviction. According to Bloomberg, the average monthly trading volume for stocks was down 32 percent since October 2011 (see
Figure 2.2
). And it’s been down almost 50 percent since 2009.

Figure 2.2
Stock Market Volume Is Falling

The stock market has risen from the depths of the financial crisis on greatly falling volume indicating a lack of widespread market support.

Source
: Bloomberg.

But, despite all this, the market has gone up, which in the end is all that most investors care about. Part of the reason it has gone up are the good numbers we have seen, most notably in employment. Up until April, we had 11 months in a row where we created over 100,000 jobs.

However, the economy clearly began to slow down in late spring. Job growth fell well below 100,000, and it had been declining every month in 2012. Other indicators were indicating a fairly sharp slowdown. That led to a lot of readjustments in economic outlooks for the year. Because of these bad numbers, in June, Goldman Sachs revised their estimate for GDP growth in 2012 to 1.6 percent from 3 percent in the spring.

We had a good increase in manufacturing since August 2011, but that, too, slowed down in the spring. Future manufacturing growth will likely be crimped by declining European and Chinese demand.

There was a lot of cheerleading going on since August when things were looking bad. No surprise. Remember the big cheers over holiday sales on Black Friday in November 2011? But when the holidays were over, they were actually flat after adjusting for inflation.

Despite the cheerleading over the fake “good” numbers, they carefully ignore one of the most important real numbers: how much we borrow each month. No one even talks about how government borrowing is increasing (see
Figure 2.3
). Do you ever see it as one of the major numbers of the month? Yet it is the most important number of the month by far. Without that money we would not only be in recession, we’d be in an extremely deep recession because, without it, the stock, housing, private credit, and consumer spending bubbles would pop. Lack of borrowing would set off a vicious downward spiral. Yet do you see that often mentioned on the business TV shows or the major financial print media? No one mentions how vitally important massive borrowing (made possible by massive money printing) is to our continued “recovery.”

Figure 2.3
Increase in GDP and Government Borrowing, 2008–2011

The “recovery” is being driven by government borrowing and money printing. Increased government borrowing greatly exceeded
all
increased growth in GDP.

Source
: U.S. Department of Treasury.

The Fed’s Next Steps

So what’s a Fed to do? The stock market is up. The economy is doing okay, especially to cheerleaders like the Fed. Europe is no longer on the doorstep of a financial crisis. There’s no real need to print money right now. Yet they keep talking about it. Maybe they want to keep assuring the stock market that they stand ready with the money hose should it be needed. They might be much more concerned about contagion from Greece, Spain, and Italy than they are saying. They also may see that this “recovery” is very fragile. We don’t know, but we think another round of money printing is likely this year or in the first half of 2013. However, it’s definitely a wait-and-see situation.

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