Billionaire investor George Soros grabbed headlines last week when he warned that China has a major adjustment problem. I would say it amounts to a crisis. When I look at the financial markets there is a serious challenge which reminds me of the crisis we had in 2008.
Not everyone thinks the current financial landscape is as bad as Soros was indicating, but given that hes worth about $27 billion and ran a hedge fund that returned an average of 20% from 1969 to 2011, one discounts his diagnosis at his or her own risk.
However, Soros is not a lone voice crying in the wilderness. Some very serious money managers and investment banks are issuing warnings of their own, particularly about stocks. Although the Chinese stock crisis has stabilized somewhat in the past week, plunging oil prices are among the distress signals indicating all is not right with the global economy.
Lets start with the bond worlds top investment guru, Jeff Gundlach, whose DoubleLine Capital firm beat 94% of its peer funds last year:
- Gold key to capital preservation: During a recent presentation Gundlach, who last year was criticizing the Federal Reserve for raising interest rates amid a nascent U.S. economic slowdown, expressed his concerns about 2016.
Falling commodity prices are symptoms of Chinas struggling economy, he warned, and the sub-$30 oil prices that have jolted the junk-bond market will eventually spill over into the stock market and could even stoke geopolitical instability in regions like the Middle East.
This is a capital-preservation market, not a money-making environment,he said. 2016 is not looking all that great, potentially. We could be looking at a really ugly situation during the first quarter of 2016. Its particularly more likely to happen if the Fed keeps banging this drum of raising interest rates against falling inflation.
Gundlach, however, does see at least one bright spot in gold. He thinks the metal is showing signs of a bottom and sees the price reaching $1,400 an ounce.
- 75% decline in S&P 500: Now lets turn to a new forecast by Societe Generale strategist Albert Edwards, whose bearish stance shouldnt surprise anyone who follows his analysis. Still, even for Edwards, this is a pessimistic outlook: He sees the S&P 500 dropping below its March 2009 bear-market low of 666 in a 75% decline that would take the index to 550.
Meanwhile, SocGen researcher Andrew Lapthorne said that now is not the time for bottom fishing in stocks. When we see equities starting to lose value, the immediate reaction is, Well things must be cheap. But because weve had such an outrageous increase in valuations, were a long, long way from seeing assets become cheap again, he said.
As for Chinas problems, Edwards said the effects will be far-reaching. Investors are coming to terms with what a Chinese renminbi devaluation means for Western markets, he wrote in a note. It means global deflation and recession.
As China exports its deflation, the Western manufacturing sector will choke under this imported deflationary tourniquet. Indeed, U.S. manufacturing seems to be suffering particularly badly already.
Edwards is predicting a meltdown at least on the level of the 2008 crisis. The Fed and its promiscuous fraternity of central banks have created the conditions for another debacle every bit as large as the 2008 Global Financial Crisis, he wrote. I believe the events we now see unfolding will drive us back into global recession.
- Cataclysmic year ahead, RBS says: Could Edwards be wrong? Of course. But his bearishness is almost matched by that of the 20th-largest bank in the world, the Royal Bank of Scotland.
Sell everything except high-quality bonds, its credit team advised, and its next statement sounded very similar to Gundlachs take. This is about return of capital, not return on capital. In a crowded hall, exit doors are small.
In predicting a cataclysmic year, the bank is bracing for 10% to 20% declines in global stock markets and oil prices below $20 a barrel. Theres no getting around Chinas slowdown, said one of its researchers.
China has set off a major correction and it is going to snowball, said Andrew Roberts. Equities and credit have become very dangerous, and we have hardly even begun to retrace the Goldilocks love-in of the last two years.
The bank also warned about repercussions from the Feds current tightening policy, accusing the U.S. central bank of playing with fire by raising rates in the current setting, in which U.S. manufacturing is in contraction. There has already been severe monetary tightening in the U.S. from the rising dollar.
- Cash and gold if bear market erupts: And across the pond from Scotland, J.P. Morgan Chase has issued a sell recommendation to its clients for the first time in seven years.
Our view is that the risk-reward for equities has worsened materially. In contrast to the past seven years, when we advocated using the dips as buying opportunities, we believe the regime has transitioned to one of selling any rally, strategist Mislav Matejka wrote.
One reason: Expectations for the most recent earnings season, with reported results soon coming due, are not high. We fear that the incoming fourth-quarter reporting season wont be able to provide much reassurance for stocks, he said.
Given that history shows that the first five trading days of any given year are sometimes a valid indicator for the rest of the years performance for stocks, and given that nearly half of U.S. stocks are already in a bear market, perhaps J.P. Morgans diagnosis is worth prudent consideration.
Meanwhile, another top J.P. Morgan analyst, Marko Kolanovic, specifically endorsed gold as a possible safe harbor. In case an equity bear market materializes this year, investors should benefit from increasing allocation to cash or gold, he wrote. Cash has zero correlation to all risky assets, while gold has recently exhibited strong negative correlation to risky assets (e.g. -40% to equities).
- Rail cargo levels look recessionary: The crashing Baltic Dry shipping-activity index, now at record lows, is often cited as a primary indicator that Chinas slowdown is deeply affecting global trade. And in this age of intermodal commercial transportation, one doesnt have to look too far to see trade sputtering in the U.S.
As a result, Bank of America has sent out a note suggesting that the repercussions from slowing railroad volumes point to an overall slack in the U.S. economy. We believe rail data may be signaling a warning for the broader economy, its analysts wrote. Carloads have declined more than 5% in each of the past 11 weeks on a year-over-year basis. While one-off volume declines occur occasionally, they are generally followed by a recovery shortly thereafter. The current period of substantial and sustained weakness, including last weeks -10.1% decline, has not occurred since 2009.
In a survey of 30 years of railroad data, BofA analysts found that similar periods of weakness have occurred in only five otherinstances since 1985: (1) the majority of 1988, (2) the first half of 1991, (3) severalweeks in early 1996, (4) late 2000 and early 2001, and (5) late 2008 and the majority of2009 all either overlapped with a recession,or preceded a recession by a few quarters.
Taken individually, perhaps each one of these five forecasts could be rationalized and marginalized into potential nonissues. But taken together, its hard to ignore the fact that so many voices are warning that the problems in the global economy are too large to dismiss. Now more than ever, investors need to protect their wealth through prudent portfolio diversification, including defensive measures like substantial allocations to cash and tangible assets such precious metals (gold and silver) and rare coins.