Modeling, Analytics and Business Intelligence

Two Must-Read Articles from Barron’s: 1 of 2

Posted in Economy, Investment by Sanjay Bapna on December 28, 2008

Summary of: The Pain of Deleveraging Will Be Deep and Wide

Felix Zulauf Sept. 22nd, (Appeared after Lehman’s b/k)

…the investment-bank giants that have been the major creators of credit in the last cycle – (when that credit) turns down, the fallout is going to be terrible.

So far, what we’re seeing is the pain in the financial system. Later on, we’ll see the echo effect of the pain in the real economy.

Fiscal Stimuli: Governments, particularly those in the industrialized economies, will use fiscal stimuli to prop up the system and prevent them from collapsing. Usually, those stimuli are a little too small to really have a lasting impact, which is usually spent after two to three quarters. So we could have a pop in the market in ’09 and the economy into 2010, and then it disappears again; then there is the next fiscal program, and so on. That can go on for a long time.

Government debt is going to rise dramatically over the next five to 10 years. Government debt is at 300% of [gross domestic product] in most industrialized countries, if you calculate correctly. That can increase to 400% and 500%, but at some point the government-bond market will not take this without any consequences. That will lead to rising long-term interest rates. But because the economy is not on solid footing yet, short-term rates will stay low for a long time. So you will have a very steep yield curve for many, many years (Sanjay: true) , and this is bearish for bonds since their prices keep falling (Sanjay: not true right now).

Inflation: I think for cyclical reasons that inflation will probably drop sharply into ’09, partly due to lower commodity prices (Sanjay: true) But what’s more important thereafter is that there will be a secular rise of the inflation rate.

The Fed Program to work: It will work, but it has to be at least $1 trillion in size and the Fed has to help by cutting rates (Sanjay: TARP was less than $1 trillion)

Euro Zone: Short term, it will probably get a little bit worse in Europe, because we have a different policy mix than in the U.S. (Sanjay: true)… So Europe could get hurt a little more than the U.S. in the short term, but I think it will do better over the medium term. The U.S. is indebted to the rest of the world; that’s a major difference.

Emerging Economies: Even emerging economies are getting hurt. … But these countries have a better situation from a very, very long-term point of view because of demographics. They are much younger nations. They are much lower in their standard of living, they are going up the ladder, and they are competitive.

…what used to be a big stimulus for emerging economies will be curtailed and it will hurt those economies in the short run much more than the markets assume (Sanjay: true).

Future of Global Economy: The U.S. economy goes flat for several years, and from time to time there probably will be major fiscal programs, each one bigger than the previous one, to help the economy. Europe will be similar; its potential growth is relatively low, with a stagnating population. The emerging economies have much higher potential growth rates. The emerging economies have much higher potential growth rates.

… it is going to be a very tough 2009, a global recession.

Promising Industries in the Future: could again be infrastructure-related assets or commodity-related assets that will perform very well. If I’m right in this scenario, what will happen is we will create a stimulus to grow in the future. And those who grow the best in a world of stimuli will be those that have the highest growth potential, namely the emerging economies.

Investment Opportunities: I’m not interested in any longs in equities. If you are an optimist by nature and if you want to be long, the one area that you should look at is daily necessities, notably consumer staples. Companies like Procter & Gamble [ticker: PG], General Mills [GIS] and maybe Johnson & Johnson [JNJ]. Those are the defensive names. But I have absolutely no interest in investing on the long side in anything that is cyclical in nature, because this cycle could last longer on the downside and go deeper than most investors assume.

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