Sharemarket crash points to deep downturn: Gottliebsen

The weakness in sharemarkets here and the volatility abroad contains a nasty message for us all. Overnight it was confirmed that Germany is already in recession, the rest of Europe will surely soon follow.

The weakness in sharemarkets here and the volatility abroad contains a nasty message for us all. Overnight it was confirmed that Germany is already in recession, the rest of Europe will surely soon follow. The downturn will be savage in the US too, where markets have staged a remarkable recovery in the final hours of trade.

Profits from a wide range of companies will be hit. Sometimes the market is wrong, but it is almost never wrong when it comes to the huge downward movements that we have been seeing.

We are watching the beginnings of a significant fall in asset values and profits that will extend over a number of years. George Soros summed up the outlook in grim terms recently when he said “a deep recession is now inevitable, and the possibility of a depression cannot be ruled out”.

Soros said that hedge funds will be “decimated” by the current financial crisis and will be forced to shrink their portfolios by 50% to 75%. He could have added that the big investment/broking houses are doing the same, and this is a key force in the current market fall. But what is happening goes a lot further. We are seeing a deleveraging of the whole world.

One of the world’s leading economists over the last 25 years, Morgan Stanley’s Stephen Roach, was a “mad bull” of the 1990s and told everyone that the Asian crisis was merely an interruption to the market.

Then he changed from bull to bear, during which time he picked the dot-com crash. For most of the current decade Roach has been warning about the bubble that has now burst.

Unfortunately he was too early, because he did not pick the extent of the sub-prime fiasco. Morgan Stanley did not embrace his warnings. The fall is bigger than even Roach anticipated, but given that he has been predicting accurately what would occur for so long, his forecasts of what is now ahead are very important.

Roach has told me that he wants to revert to being as optimistic as he was in the 1990s, but that he can’t do it because the US financial disaster is now spreading to the rest of the US economy and we are in for a deep and extended downturn.

And that’s exactly what the sharemarket is telling us.

But Roach’s message is even more chilling for Australia. He believes low commodity prices are going to be with us for an extended period because the Chinese stimulation package will not turn the situation around. That means that most of those mining projects we thought would boost our economy will be mothballed, although we might get the odd gas project off the ground.

On a regional basis that means the WA boom will be crushed. Queensland will also suffer. But the whole country will be affected. Whereas low commodity prices will be a boost to places like Japan, China and the US, they will hurt Australia badly.

This latest blow comes at a time when Australian consumers are deep in debt. The Government has incorporated a level of revenue from mining into its spending that is simply going to disappear in a year or so. And assuming Roach is right, it will not return for some years. So this Government is going to have to reduce spending excesses and may be forced to tackle its level of bureaucracy.

Meanwhile the boost to consumers in China will lessen its ability to finance the US deficit. America needs to start lifting its savings and lowering its deficits. If it goes on a tax cutting spree there will be a short term benefit but long term heartache.

The Federal Government probably doesn’t know that there is an economist who has been getting it right for more than 25 years. Stephen Roach’s message to Australia would be to follow his US recovery recipe – lift our savings and invest in infrastructure. Roach would also say: “Don’t go for the quick tax cut boost, which will be very short term.” But of course that’s exactly what the new Rudd Government is doing.

It will cry that it has no money for infrastructure. But what it needs to do is create low risk infrastructure vehicles where the revenue is guaranteed and begin to tap a very shocked superannuation market that right now doesn’t want to hear about infrastructure.

In the sharemarket it’s clear that the deleveraging is reaching hysterical proportions. But that will be followed by consumers who despite lower interest rates will not risk high debt. And even if they are prepared to borrow, banks will say no. The sharemarket is the forerunner of lower asset values across the board, including property.

This article first appeared on Business Spectator