By William Patalon III
Money Morning/The Money Map Report
As rocky as the global markets have been, the worst is yet to come, the Royal Bank of Scotland Group PLC (ADR: RBS) warns.
RBS analysts have warned clients to brace for a full-blown crash in the global stock-and-bond markets over the next three months as the conflicting realities of slowing growth and rising inflation paralyze the world's major central banks – causing "all the chickens [to] come home to roost," Great Britain's Daily Telegraph newspaper reported.
The report, which first surfaced late Wednesday, raced across the Internet yesterday (Thursday), though it appears that European news organizations are giving it much wider play than their U.S. counterparts.
The predicted swoon would cause the U.S. Standard & Poor's 500 Index – already down 15% from its trading high of 1,576.09 reached Oct. 11 – to nosedive all the way down to 1,050 by September. For the closely watched, broad-based U.S. stock index, that would represent an additional decline of 22% from yesterday's close of 1,342.83 – and a total decline of 33% from its Oct. 11 apex.
Story continues below…
This is the worst forecast of any investment bank survey followed by Bloomberg News.
"The Europeans, in general, tend to have much-more conservative banking systems and financial vehicles than we have here in the United States," said Keith Fitz-Gerald, investment director for Money Morning. "They've been through centuries of economic and financial conflict. For that reason, they are much more pre-conditioned and predisposed to listen to major warnings like this one."
The sell-off that RBS expects to deepen started last fall after the U.S. subprime-mortgage crisis turned into a full-blown credit debacle even as it took on a worldwide reach. Banks and brokerages have written off roughly $400 billion in assets. But that torrent of write-downs may get even worse: At a conference in Monaco yesterday, New York hedge fund manager John Paulson estimated that this amount will triple to $1.3 trillion – a reality that will clearly exacerbate the decline of the financial markets worldwide, Bloomberg reported.
The predicted "contagion" will spread across Europe and will afflict the emerging markets, including the fast-growing economies in Asia, the RBS research team wrote to clients in a June 11 report. RBS is Britain's second-largest bank.
A sell-off of that breadth and magnitude would represent one of the worst bear markets the world has seen over the last century, and would clearly have implications reaching beyond stock-and-bond prices.
"A very nasty period is soon to be upon us – be prepared," said Bob Janjuah, 42, a U.K-based credit strategist for RBS.
In the credit markets, high-grade corporate bonds would see their trading values soar, while their lower-grade counterparts would see their own values plunge, thanks to a "renewed bout of panic on the [global] debt markets," the Daily Telegraph reported, citing key excerpts of the internal RBS report.
Addressing the fallout that RBS expects to see in the bond markets, Janjuah wrote to clients that he couldn't "be much blunter. If you have to be in credit, focus on quality, short durations [and] non-cyclical defensive names."
The credit analyst – who became an industry star after his grim warnings about the current global credit crisis played out as he predicted – also counseled clients that "cash is the key safe haven. This is about not losing your money, and not losing your job."
RBS expects the U.S. stock market to rally into the early part of July, thanks chiefly to the boosts provided by the aggressive rate-cutting campaign that the U.S. Federal Reserve launched last September and from the tax-rebate checks that were initiated by the Bush Administration's economic-stimulus plan. Those benefits will soon sputter and the real damage from soaring food-and-energy prices will finally become apparent.
Unfortunately, the world's leading central banks may not be in the position to help out this time around. In fact, both the Fed and the European Central Bank (ECB) face a so-called "Hobson's choice" as workers start losing their jobs en masse and lenders continue to cut off credit, the Daily Telegraph said.
Usually, the central banks would just cut interest rates or employ some other form of monetary stimulus to help their economies regain positive momentum. That's not an option this time around: The soaring food-and-energy prices are already pushing inflationary pressures to levels that will destabilize stock-and-bond markets.
The bottom line is that the U.S. economy could end up with stagflation, the rare but hard-to-eradicate one-two punch of high unemployment and high inflation.
"The ugly spoiler is that we may need to see much lower global growth in order to get lower inflation," Janjuah said. "The Fed is in panic mode. The massive credibility chasms down which the Fed and maybe even the ECB will plummet when they fail to hike rates in the face of higher inflation will combine to give us a big sell-off in risky assets."
And Europe won't dodge the bullet, RBS debt-markets chief Kit Jukes said.
"Economic weakness is spreading and the latest data on consumer demand and confidence are dire," Jukes told the newspaper. "The ECB is hell-bent on raising rates. The political fall-out could be substantial as finance ministers from the weaker economies rail at the ECB."
"What is being discussed here is absolutely within the realm of possibility and is a possibility that we've been discussing here in Money Morning for quite some time, now," Fitz-Gerald, the Money Morning investment director, said in the interview yesterday. "And we've never wavered in that conviction. In situations like this one, the best offense is a good defense, which consists of an appropriately structured and diversified portfolio of holdings that emphasize stability and balance, and current income derived from global markets. That kind of portfolio may well weather this kind of storm much better than a U.S.-based portfolio in isolation.
"This report – and others like it – may be extremely unsettling to individual investors. But the historical record is unequivocally clear that the best profit opportunities come when everyone thinks the skies are darkest. Savvy investors at this point in time can take steps to help them avoid this even if the rest of the world sinks into an economic cataclysm."
News and Related Story Notes:
Stocks, Credit Slump Will Worsen, RBS's Janjuah Says.
The Daily Telegraph (U.K.):
RBS Issues Global Stock and Credit Crash Alert.
Ready for a 300-point Drop in the S&P 500?
An Even Bigger Bear?
The Daily Telegraph (U.K.):
RBS Global Crash alert: Quotes.
The Daily Telegraph (U.K.):
RBS Stock Market Alert: Fund Managers React.
About the Author
Before he moved into the investment-research business in 2005, William (Bill) Patalon III spent 22 years as an award-winning financial reporter, columnist, and editor. Today he is the Executive Editor and Senior Research Analyst for Money Morning. With his latest project, Private Briefing, Bill takes you "behind the scenes" of his established investment news website for a closer look at the action. Members get all the expert analysis and exclusive scoops he can't publish... and some of the most valuable picks that turn up in Bill's closed-door sessions with editors and experts.