Preparing for the crisis
September 23, 2011

Preparing for the crisis - Zelia Cardoso de Mello

I don't know how you are seeing the current economic situation and your outlook on it, but to me, it looks grim. We have had about two months of intense volatility in the markets: on July 22nd the Dow was as high as 12.718 and on September 10th as low as 10.825. Some days we have some good news, but most of the time it is bad. Interestingly enough there isn't a different fact or one "new" piece of bad news. The newscast is pretty old and repetitive: by now we have all heard a million times that Greece is about to default and that next in line might be Spain or Portugal or Ireland, or the banks with exposure to the Greek debt. Greece is in talks with the troika- EU, the International Monetary Fund and the European Central Bank- to discuss the next installment. The Euro is about to collapse and Germany's economy is slowing down. The American congress is deeply divided and there is no hope that agreements to stimulate the economy or create jobs will pass.

Notwithstanding the fact that the indicators are somewhat mixed, making difficult at this point to conclude that a recession is on the way, there is sufficient evidence of a slowdown: the new estimates indicates that in the second quarter of 2011 real consumption expenditures grew at 0.4%, much smaller than the 2.1% we saw on Q1 and 3.6% in Q4 2010. Republicans' only priority is to be sure that Obama is a one-term president and Obama finally came out from the dead and showed a resolve that had been missing since inauguration. The problem is that it might be too late for him and for the economy. To add to the problems, let's not forget that the debt ceiling vote was not a clean, simple vote: it has several provisions, the most important one being that Congress has to vote on 1,5 trillion in savings by November- December or else the raise on the debt ceiling will be only 1,2 trillion. If the Committee created to find the savings to pay for the increase fails to do so- or if the Congress fails to vote- then the federal debt will have to decrease by at least $1.2 trillion over ten years, and there is a mechanism that will implement automatic spending cuts to both discretionary and direct spending. Either way the impact on the economy will not be positive.

There is no way emerging markets can extricate themselves from the developed world's mess: they will be affected in one way or another. Besides, they have their own challenges. The Brazilian government -while one more Minister went home on corruption accusations, making him the fifth so far- decided to cut interest rates and the Real has devaluated more than 20% so far, and at the same time the rise of inflation is still a threat. China will slow down as there is a limit for all of that expenditure in bridges, high-speed railways, highways, airports, luxury apartments. This was very important in order to respond to the 2008 decline in exports, but there is no way they can keep up with it. Also, this was financed with debt leading to an increase on the debt-GDP ratio.

So there might be someone out there that believes in miracle and believes there is solution for Greece, that the Euro will not collapse and jobs will be created In the US. I doubt it. As I stated before, the problem is the Euro itself, and in the developed world, the problem is the leadership. The leaders decided- since 2008- to implement a new form of capitalism, capitalism without risk: if you are a bank, you are allowed to make the wrong loans because at the end of the day the Government will bail you out. Can someone explain why the ECB is bailing out the banks and not the countries? Why the people of Greece have to suffer and not the bond holders? Why in the United States those already suffering from unemployment have to fear cuts in Medicare, Social Security and other programs while the corporations can spend millions of dollars in "entertainment" and have a tax deduction?

Until Wednesday, the 21st, I didn't know if we were going into another recession because the signals are mixed. Then Bernanke announced new measures and that is an indicator that things are bad. Even worse, the measures will not help the economy. On September 20th the IMF cut its forecast for global growth to 4%. Sooner rather than later, corporates will lower their earnings estimates and since no good solution will be found for Greece and Co., volatility will be the new normal. Unfortunately, more than volatility I think we are about to come to a second crisis (the first was in 2008), this time led by the sovereign governments.

So what are you to do in the meantime? How do you prepare for a grimmer situation where your savings and investments will certainly have smaller returns if any return at all? In a situation like this, all classes of assets will be affected, some more, some less. So there is unfortunately no place to hide. One can think about triple A corporate bonds or stocks with high dividends. That is an option if you are willing to accept very low returns. However, crisis means opportunity and if you read my previous newsletters (and agreed with me) you should have cash so you should be able to take advantage of the crisis: if assets are going down, whoever has cash and patience can make good deals in the real estate market and can hunt for good undervalued stocks and for good fixed income opportunities. If you want to be more aggressive, go ahead and short the market.

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