Sound the alarm bells! A collision with reality is dead ahead!
The elephant in the room blasted out a mighty honk this weekend in a report by Access Economics, as reported in today’s Australian. “Batten the hatches,” Access says. “This is not just a recession. This is the sharpest deceleration Australia’s economy has ever seen.” Access adds that the federal budget is “buggered.”
“Leading economic forecaster Access Economics warns in its quarterly Business Outlook, released today, that the nation’s economic boom will ‘unwind scarily fast’, halving corporate profits, costing more than 300,000 people their jobs and blowing out the current account deficit to more than $100 billion.”
Dire stuff indeed. But the question from last week remains, is this massive dose of negative news already priced into Australian stocks? Or is it a further hammer blow that will drive them to new lows?
So far this morning, the market seems to be taking the prospect of a prolonged earnings recession fairly well. Or maybe it’s just in denial. The Access report correctly points out that the fall in commodity prices will dry up government royalties and corporate taxes. This will lead to higher budget deficits, more unemployment, and a contraction in the mining industry after four years of break-neck expansion.
Australia’s government is now in the same pickle that Gordon Brown and Barrack Obama find themselves in: how do you distribute enough borrowed loot to keep your economy from shrinking without igniting inflation and a weakening of your currency? And if you accept that the government really can step in and spend money while households and businesses are not, where does it spend it? Roads? Bridges? Booze? Pokies?
Those are mostly political questions. Economically, it’s hard to see how corporate earnings will recover this year. Demand is falling. Miners are winding up projects. All this being the case, don’t look for earnings to lead to a big bear-market rally.
In fact, as we mentioned last week, we think it’s likely that you’ll see a large exodus of institutional money out of common stocks and into corporate bonds. Corporate bond yields are now much higher than what you’ll find in U.S. government bonds. And it is the habitual thing to do, changing asset classes rather than liquidating altogether.
The big sleeper so far this year is oil. Oil prices have fallen 25% since rallying to just over $50 last week. The leverage is out of the oil market. And with a global recession, the IEA now predicts oil demand will fall for the second year in a row. It’s the first time that’s happened since 1983.
But the real story is how the falling oil price is hammering oil producers. Multinational oil companies are cutting back exploration programs. They’re not looking for oil. And you can’t produce what you can’t find.
As for the national oil companies in Mexico, Venezuela, and Russia, well they too are being hit hard by the falling oil price. During the big run up to $150, national oil companies were cash cows. But it now appears that little of the oil bounty was reinvested in new production or even maintenance of existing production.
So what do we have now? We have a situation here. A situation where the falling oil price is leading a big reduction in oil production. This will match, for a while reduced demand for oil. But we also think it’s baiting the trap for a huge blowback in oil prices. And the spark for that could be geopolitical. More on that tomorrow.
It didn’t seem possible, but things are getting worse for Americas largest commercial banks, Citibank and the Bank of Amerika. “The U.S. government, recognizing that the banking crisis is far larger than originally thought, is laying the groundwork for a second phase of its rescue attempt, with plans to purge bad assets that are paralyzing the financial system,” reports the Wall Street Journal.
Aha! Remember that phrase from last week, “incorporating the public debt?” This was the alchemical process by which a huge slab of outstanding debt was transferred to a new entity and converted into, ahem, “capital” in 17th century Britain. It now looks like you’ll see a new large national financial institution in America this year. It may even resemble a giant vacuum, or a garbage dump.
No matter what it looks like, it will be the receptacle for the metastasizing debt that is killing the financial sector. The Journal says that the discussions for the new “Bad Bank” between the Fed, the Treasury, and the FDIC, “show how the rapid deterioration of bank assets is outpacing the government’s rescue efforts. Banks are now struggling not only with the real-estate investments that sparked the crisis, but also with the car loans, credit-card debt and other consumer debt that have taken a hit with the faltering economy.”
We may as well get on with full nationalisation of the financial system. Thus far, it’s been incremental. But the end game is increasingly obvious now. Governments will either begin guaranteeing all mortgage lending and corporate debt (as plans in the UK suggest) and/or assume responsibility for the toxic assets impairing financial balance sheets (in exchange for equity).
What this means for stocks, paper currencies and gold bears more discussion. More on that tomorrow.
for The Daily Reckoning Australia