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For What Its Worth: December 08

Ireland is up the creek. But as an open economy, our ability to come out of recession after taking all the pain from a housing bubble burst largely depends on what’s happening outside. So if you’re ready to look beyond all the doom and gloom, there are reasons to be optimistic.

• First of all, expect lower mortgage costs next year as interest rates fall, but watch out for banks that don’t pass these through. If you can, stay on variable rates. The ECB base rate could fall once again – possibly even as low as two per cent as earlly as next April – before we’re out of the mire.
• The aggressive action, led by the UK and EU, to inject equity in banks, guarantee interbank lending and provide hort-term liquidity, added to US and Asian actions, has stopped the rot in the banking crisis. However, the new banking model to emerge, one characterised by lower leverage and prudential lending, will lead to a different credit climate.
• So what will be the impact of this new model on the global economy? At best there will be a slowdown in economic growth next year in addition to localised recessions in economies overly reliant on asset bubbles fuelled by sloppy lending. This is already factored into equity markets which are predicting lower plc earnings. But such was the oversell, driven by fear, that equity markets are more sensitive now. In short, lots of bad news is already factored into equities.
• There is likely to be a two-step cycle now. First, a deflationary cycle characterised by aggressive rate cutting including by the ECB in response to economic cooling, followed by an inflationary cycle as the world grapples once again with scarcity in natural resources, especially oil. The imminent IEA audit on world oil reserves will bring a sharp and timely reminder on the fragile state of oil reserves and the need to accelerate investment in renewable programmes.
• Huge capital sums idle in cash, and other safe havens, awaiting the stimulus to re-enter markets. Markets appear to have tested the floor of the bear market but this is likely to remain fragile well into next year and will be vulnerable to any overwhelming bad shock. Nevertheless, it is a good time to invest in assets to catch the recovery.
• "Such is the tightness between supply and demand, falling commodity prices,especially after the speculative bubble burst, is inevitable but short-term.”
• Depressed growth means lower demand for commodities, including oil. Such is the tightness between supply and demand, falling commodity prices, especially after the speculative bubble burst, is inevitable but short-term. I remain convinced that a return to normal global growth, perhaps as early as 2010, will see a return to the long commodity bull market. This means holding assets in these sectors and increasing allocation to add more energy, alternative energy, energy efficiency and natural resources at cheap prices to balance sheets. The Obama election will supercharge US alternative energy growth.
• A rolling sequence of interest rate cuts responding to cooling consumer spending in Europe and commodity deflation means less for cash deposits – perhaps even below the inflation rate – and short-term gains for bonds. But a return to normal global growth, especially if Chinese and Indian growth stays robust, will restart a long-term high inflation cycle; unwelcome news for both cash and bonds.
• Large capital flows back to the US Dollar to meet cash calls and pay for redemptions will continue to strengthen the dollar, which will gain against the Euro, so expect more US tourists next summer. The US is likely to emerge ahead of Europe from the recessionary cycle but long-term, I still think the Dollar will weaken as oil spikes again and the US grapples with all the debt it owes to the rest of the world.
• Unavoidably, the Irish recession will be longer than foretold and more severe given the scale and depth of the housing bust, the reliance upon it to feed public sector expansion, the inability of the current administration to untangle its own legacy and the length of time it will take for distressed debt to be flushed out.
• There was an economy after all at the back end of this crisis, one worth continued investment. You either see this as a cyclical part of economics and a buying opportunity, as Warren Buffet has, or you don’t and remain in cash.
• Just as coolness is needed to greet fear and panic as the temporary imposters they are, patience and faith in human nature, in human greed, innovation and invention is needed to stay in the game long enough to reap the rewards.