Global recession could be around the corner if US drowns

Updated: 2012-10-27 06:38

By Puru Saxena(HK Edition)

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Global recession could be around the corner if US drowns

The stock market is in correction mode and as long as the trend is down, capital preservation should be the top priority. It is notable that in this earnings season, several bellwether companies have missed estimates and they have disappointed the market. Furthermore, most corporations have lowered their forward guidance. These are negative developments which imply that a global business slowdown or recession may be around the corner.

In the investment business, nothing is set in stone but when a market sells off on extremely positive news, that is usually a bad sign. For instance, only a few weeks ago, Mr Draghi pledged to save the Euro and Mr Bernanke unleashed an open-ended QE. However, rather than stage an impressive advance on such bullish news, the stock market failed to rally and Wall Street has now sliced through its September low. Furthermore, given the ongoing slowdown in the global economy, it is conceivable that stock prices may continue to slide for several weeks or months. In any event, during this downtrend, investors should defend capital and avoid purchasing risky assets.

Over in the commodities complex, both copper and crude oil are back below the 200-day moving average. This should come as no surprise to our readers as we have been saying that given the weak state of the world's economy, a sustainable commodities rally is improbable. In our view, the industrial commodities will continue to struggle and if the US enters into a recession, this sector may face intense selling pressure. Thus, this is not the time to have exposure to the commodities complex.

Turning to precious metals, the charts reveal that both gold and silver are currently correcting their recent gains. Nonetheless, we have been stopped out of our positions in physical bullion and we do not have any exposure to this asset class. In our view, if the US enters a recession and its currency rallies, the prices of gold and silver will depreciate. So, if you still have positions in physical bullion, you may want to exit on any further US Dollar strength. Contrary to popular belief, we are of the view that both gold and silver will suffer during an economic recession and if deflationary fears escalate, their prices may weaken considerably.

In the currencies patch, it is interesting to note that despite the Fed's QE-ternity initiative, the US Dollar is refusing to break down and this is a sign of extreme strength. Remember, the American central bank is creating $40 billion out of thin air each month, but the world's fever chart is not declining. This implies that the ongoing private sector debt deleveraging is thwarting the Fed's inflationary agenda. Once again, the why is irrelevant and price action is all that matters. At present, the US Dollar Index is sitting just below its overhead resistance and a close above the 80.21 level will usher in the next uptrend. If the US Dollar manages to clear that level, it will imply that the Fed's QE program is not working and strength in the greenback will be bearish for all risky assets.

Finally, over in the bond market, US Treasuries have weakened a tad but given the state of the economy, this selling should be transitory. If the US economy slows down or contracts, long dated US Treasuries will probably rally and the yields may decline to record lows. Consequently, we currently have a modest exposure to this asset-class. Elsewhere, high yield corporate bonds are still an interesting option for income-seeking investors, although they may also suffer during a recession. Thus, if you do not need the income or are unwilling to withstand near term volatility, now may be a good time to exit this space.

(HK Edition 10/27/2012 page2)