The Retail Collapse Continues

Is it stocks or is the economy? Friday's action on Wall Street sets up a big theme you can expect to hear a lot in the next three months. Namely, "stocks lead the economy."

That theme will be popular for a simple reason. The global economy is awful. If you're looking for a justification to get back into shares at these levels, you have to convince yourself that the financial markets have bottomed out, even as the bottom falls out of the real economy.

It's a risk. But hey, 2008 was the year risk was re-priced. Capital, once abundant, is now scarce. And even so-called "safe" investments like U.S. Treasury bonds are no sure bet.

However you can't ignore the action in the market. Since falling to 7,550 in November, the Dow is up nearly 20%. Friday's 258 point rise sent the index up three percent on the day and above 9,000 again. It gives the Aussie market a positive lead into the week.

But beyond sentiment, it is hard to find much in the way of positive economic news. The double helix of the global economy-U.S. consumption and Chinese production-is coming completely unravelled. To the extent that the entire dynamic was a product of cheap money and global imbalances, you wouldn't expect it to survive a contraction in global credit. But its collapse is pretty breathtaking.

The retail collapse in the U.S. continues. It's Armageddon for the sellers of stuff. Bloomberg reports that, "The International Council of Shopping Centres in New York predicts 73,000 U.S. stores may shut in the first half of 2009 after what may have been the worst holiday-shopping season in 40 years."

Your editor strolled though a massive retail space in Colorado last week, the Flatirons crossing mall. One thing you notice right away is the number of vacant store fronts. The other is the massive discounting going as retailers try something, anything too boost sales. It's too late for many of them. Over 148,000 stores shut their doors last year.

With U.S. consumer demand collapsing, the number of Chinese factories cranking out "stuff" is set to decline as well. "Trade finance is collapsing," Victor Fung tells the International Herald Tribune. Fund is the chairman of the Li & Fung Group, a supply chain management company that connects factories in China with retailers in the United States and Europe.

Fung says, "We've got orders we can't ship right now." He estimates that 10,000 of the 60,000 factories in China owned by Hong Kong interests have closed or will close in the coming months. "China's manufacturing shrank for a third month in December as export demand fell, suggesting an economic slump is worsening despite government efforts to shield the country from global turmoil," reports the West Australian Business News.

The Chinese and American governments have both rolled out their own respective plans to "deal" with the crisis and stimulate the economy. But you begin to get the feeling this economic relationship has reached the end of its useful life. But what will it mean for stock markets?

And more questions. What will it mean if China no longer racks up large trade surpluses because U.S. consumers have gone into their shell? Without trade profits to recycle back into American capital markets, will interest rates on U.S. government debt rise in 2009? And what does all this mean for Australia's resource-reliant economy?

Jeez. That's a lot of questions to begin the New Year with.

Answers?

Your editor admits his brain is a little scorched after enjoying the spectacular weather yesterday in Melbourne. But here is the beginning of an answer...the U.S.-China relationship that drove most of the global growth in the last ten year is dead. This does not mean that the U.S. and China will now become economic foes.

But it does mean that the relationship simply can't survive a world where consumption is no longer financed with credit. China's growth is going to have to become less U.S. centric and more organic. Whether or not that is really possible is another question.

For 2009, however, we'd expect to see the model fall apart even more than it did in 2009. That is, the destruction of leverage in the financial markets will have more real world consequences. Factories will close. People will be fired. For commodities, non-competitive producers and many explorers are already facing extinction. You can expect to see more culling this year.

As far as financial markets have already fallen, it's hard to see them rallying strongly for the year when the global economy is weak (and getting weaker). Thus this year looks like a period of consolidation. The scale of economic activity will contract. Real economic growth in China, India, and the developing world will be delayed by the final acts of the credit crisis.

In the meantime, investors are going to have to deal with the huge increase in the amount of borrowing by the U.S government. The supply of sovereign debt is increasing. The world's stock of real available capital is not. This argues for gold in 2009.

But what about the private sector? Government borrowing is going to crowd out private borrowing. It's not clear, for investors, which industries will benefit from all that new government borrowing and spending, or whether that's even an investable idea. More on that tomorrow.

Dan Denning
for The Daily Reckoning Australia

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