Category Archives: Investment Planning

How To Weather The Next Economic Downturn

moneyMy Comments: It’s again a question of WHEN and not IF. Despite the fact that most clients understand intellectually that markets go up and down, whenever there is a drawdown, emotion tends to overwhelm intellect. And it happens to me too.

For the past few months the markets have trended down. All the while, volatility, driven by both a slowdown in China and the uncertainty regarding interest rates and whether the Fed is going to finally make a move, creates an uncertain future for most of us.

The chart featured here suggests we are in for at least several more months of drawdown before a discernable upturn can be identified. Whether you can weather this economic downturn remains to be seen. While the comments reference institutional investors, there are parallels for you and I here as well.

Ben Carlson October 28, 2015

My colleague Josh Brown had an excellent piece in the most recent Fortune Magazine that asked a simple, yet loaded question:  Are You Ready for the Next Bear Market?

As we’ve seen from the seemingly never-ending market crash predictions over the past few years, no one really knows when the next bear market will hit. But we do know that bear markets are a natural outcome when you mix an uncertain future with human emotions that tend to take things to the extremes on the greed and fear spectrum.

Here are ten of the worst bear markets since 1926:

drawdownsI’m a huge proponent of thinking and acting for the long-term to be successful as an investor. But to be able to take advantage of the long-term you have to be able to make it through the short  to intermediate term.

As you can see from this chart, the time it takes to round-trip from some of the worst drawdowns, which can last for a number of years. On average, it has taken the stock market roughly 4-5 years to recover back to the prior peak. In my experience, these periods are where the majority of mistakes are made by investors.

One of my biggest realizations from working in in the institutional money management business during the financial crisis is that far too many organizations were unprepared for a severe market disruption. They didn’t understand what they owned.

It turned out that many of their portfolios were operationally inefficient. They didn’t have sufficient liquidity to survive or even take advantage of opportunities from the brutal bear market.

And the worst part is many organizations were forced to cut back their spending distributions from their portfolios. Many charitable organizations had to lay people off because of it.

One of the things I’m most excited about in my new role with Ritholtz Wealth Management is that I get to help institutions create investment plans that will give them a high probability for success during these situations. That means not only achieving their long-term goals, but also surviving severe market disruptions without compromising the organization’s mission.

Financial markets are a complex adaptive system, so the automatic response by the majority of institutional investors is a complex investment structure. These complex portfolios basically work until they don’t. And when they don’t work it’s usually at the most inopportune times.
With private securities, fund lock-ups and gates on investor redemptions there is no diversification benefit because you can’t rebalance to take advantage of market volatility. You become a forced seller elsewhere in your portfolio, which is a position you never want to find yourself as an investor.

My experience has been that the best risk controls an institution can implement to survive these serious market disruptions exist within a straightforward, transparent and sufficiently liquid portfolio. So what’s an investor to do with the knowledge that a bear market will hit some day, but we don’t know when?

In the words of Howard Marks, “You can’t predict. You can prepare.”

Brazil Heads Closer To Total Collapse

My Comments: Many are waiting for the penny to drop indicating a new global recession and collapse of the stock markets. Is this it?

Oct. 19, 2015 by Ian Bezek


  • Brazil’s economic “Superman” may have resigned Friday, according to conflicting media reports.
  • Brazilian shares and currency fell sharply after Friday’s market close.
    His departure would bring close parallels to Argentina’s collapse in 2001.
    Investors should avoid or short sell Brazil as the country comes closer to catastrophe.
  • It’s just about over for Brazil. The signs are clearly in place that the country is in the midst of a historic implosion.
  • Brazil is following almost precisely the same script that Argentina did between 1999 and 2001. The outcome there was a 75% devaluation of the Argentine currency, the total dissolution of the government, and a black hole of losses for foreign investors.

It’s almost eerie how close these two tales are playing out. Friday brought Brazil’s “The savior throws in the towel” moment as conflicting media reports suggest the nation’s respected economic minister may have resigned. Brazil’s stocks (NYSEARCA:EWZ) and currency knifed lower in Friday’s after hours session.

First, let’s remember what happened in Argentina so we can see what’s in store for Brazil.

Up until the 1990s, Argentina’s economy was a chronic basket case, wracked by constant hyperinflation and repeated total failures of the country’s currency and budget.

All this changed in 1991, when Domingo Cavallo was appointed Minister of the Economy. He immediately and boldly pegged the Argentine currency to the dollar 1 to 1, and prevented the government from floating more currency than it had dollars in reserve.

This sharp break with the past revived the economy, which took off at lightspeed, growing more than 50% over the ensuing 8 year period. Cavallo was widely credited with saving the economy. He exited the government in 1996 following political in-fighting.

All continued well for Argentina until 1998, when various emerging market crises in Brazil, Russia and Southeast Asia started to weigh heavily. Argentina remained firm with its ironclad 1:1 peg to the dollar, newly elected president Fernando de la Rúa campaigned specifically on maintaining the peg despite mounting international instability.

During this time, the Brazilian currency devalued sharply, as did other Latin American currencies and various European monies. As such, Argentina was tied to the increasingly overvalued US dollar. Argentina had increasing difficulty competing with its peers. Brazil, in particular wa, as its leading trading partner garned a huge advantage from the currency devaluation.

By early 2001, the Argentine economy was in year 3 of a bitter recession, and questions were mounting as to whether it could service its debts. Then Argentine-President de la Rúa, after watching various economic ministers resign eventually felt compelled to ask Cavallo to be his economic minister. This was a shocking move, since Cavallo had run against de la Rúa for the presidency in 1999.

But desperate times call for desperate measures, and it was widely viewed that only Cavallo, as the economy’s “savior” had the ability to convince the IMF and foreign investors that Argentine was able to make it through the crisis.

Take this article from March 2001 in Fortune:

Argentineans are probably feeling a sense of déjà vu right now after Argentine President Fernando de la Rua’s bold and possibly threatening move of appointing Domingo Cavallo as Argentina’s economy minister for the second time in a decade.

Domingo Cavallo stepped in as Argentina’s third economy minister in the last three weeks, taking over from Ricardo Lopez Murphy, who served a controversial two weeks before resigning Monday after outraged opposition to his ambitious cost-cutting plans.

Cavallo served as economy minister in 1991 and guided the economy out of a period of hyperinflation and spiraling currency devaluation, becoming a Wall Street darling in the process. Rua’s move is being viewed by most as the return of the savior of Argentina’s economy […]

The one thing that has been lacking in Rua’s administration is political credibility. Rua was hanging by the skin of his teeth, and selecting Cavallo was an act of desperation but a good move. (emphasis added) But it wouldn’t end up being enough. Cavallo, despite being the “savior” was unable to fix Argentina’s core problems. Its currency was dramatically overvalued, further budget cuts were simply shrinking the economy and thus never closing the fiscal hole, and investor sentiment soured again after a quarter-long uptick following Cavallo’s return.

Following the September 11th attacks and increasing global economic tensions, the IMF cut Argentina loose, denying further loans. Argentina devalued the Peso 75%, the government collapsed, the capital was paralyzed by riots for months, and finally a new socialist government took over and made the country an international investing pariah – where it remains stuck even today, 13 years later.

Brazil’s Similar Trajectory

Brazil, seeing neighboring Argentina’s success in the early 1990s, tried a dollar peg to revive their economy starting in 1994. However the upturn didn’t really gain traction until 2003. Luiz Inácio Lula da Silva was elected president, and despite campaigning on a leftist platform, ended up handling the economy more moderately than expected.

His market-friendly policies, among them picking a former Bankboston CEO (now part of Bank of America) to run the central bank, drew investor interest. The country was upgraded to investment grade, commodity exports boomed catching the Chinese wave perfectly. Millions of Brazilians were lifted out of poverty and the country’s investments boomed.

After working at the ECB, Levy in 2003 was appointed Treasury Secretary by President Lula. Levy, a University of Chicago trained economist, had all the fiscal hawk credentials and orthodox economic views that make foreign investors swoon.

Under Levy’s leadership, Brazil secured the all-important investment grade credit rating and ushered in Brazil’s investment boom. Levy left the government in 2010 and went into wealth management at Bradesco (NYSE:BBD).

Fast forward to 2014 and the Brazilian economy finds itself on the ropes. The government is now headed not by the charismatic Lula but his incompetent and ever more socialist successor Rousseff.

Brazil’s economy overheated around 2007 as the Chinese boom stimulated overinvestment in Brazil. The Brazilian Real rose too sharply, making the country’s goods uncompetitive, again repeating Argentina’s sad experience.

A key sign of an investing bubble was spotted, in that Brazil’s productivity rate almost didn’t move during the boom. Unemployment fell as sharply as it did simply because the economy was so inefficient that it had to hire excess workers to complete even basic tasks.

The overstimulated economy allowed Brazilian companies to take on too much debt, much of it denominated in dollars. Once the Real went from undervalued to overvalued, the uncompetitive nature of the economy was exposed and the growth miracle suddenly went into reverse. The falling commodity market has now moved the situation from dour to dire.

In Venezuela, the dung didn’t hit the fan until the enigmatic Chavez was replaced by the thoroughly ordinary and deficient Maduro. Similarly, the Brazilian economy immediately headed south once President Lula gave way to Dilma Rousseff. The economy was already in recession by the time Rousseff felt compelled to beg for Levy, the renowned free-market austerity hawk to fix the mess.

Like with Cavallo in March 2001, another unpopular president was forced to appoint an intellectual opponent viewed by markets as a “savior” to try to head off crisis.

When Ms. Rousseff, a leftist former guerrilla who has favored a strong state hand in the economy, announced last year that a free-market “Chicago boy” would run her finance team starting Jan. 1, it was widely viewed as a shotgun marriage. But with Brazil’s economy and public accounts deteriorating fast after years of heavy government spending, the president was under pressure to change course.

Mr. Levy, whose background includes stints with the International Monetary Fund, the European Central Bank and the asset-management arm of Brazilian banking giant Bradesco, was seen as a market-friendly face to reassure investors and mollify jittery credit agencies. He had political experience as well, having earned high marks as treasury secretary under former President Luiz Inácio Lula da Silva and as a budget-cutting finance secretary in Rio de Janeiro state.

News of his appointment initially boosted markets and Brazil’s currency strengthened, a phenomenon local media dubbed the “Levy effect.” One glowing profile late last year compared the new finance minister to Superman. (emphasis added)

10 months after Caballo was appointed in March 2001, Argentina totally collapsed.

10 months after Levy was appointed last winter, Levy is now on the brink of being kicked out and the Brazilian economy is facing an Argentine-like cliff. Levy was particularly brought in to save the country’s credit rating from going to junk and reassuring nervous investors.

He failed on all counts. Brazil has been cut to junk, investors are bailing, the Real just hit all-time lows, and now the only market friendly face in an otherwise corrupt anti-capitalist and wildly unpopular government is about to leave the government.

With Rousseff taking heat from her own supporters for allowing a tax-hiking budget-cutting “Chicago boy” to handle the economy, it’s unlikely the next finance minister will be nearly as investor-friendly.

Rousseff’s own approval rating is under 10%. The country’s institutions are completely discredited following massive corruption scandals. The country’s former crown jewel, Petrobras (NYSE:PBR), is rapidly heading toward bankruptcy.

It’s hard to see many outcomes here much different from Argentina in 2001. The government called in the economic “savior” or “superman” to save the day. They failed. Then the sitting government is booted from power and the currency is devalued sharply.

Needless to say, there’s no “buy-the-dip” opportunity here. Brazil’s Debt-to-GDP ratio has mushroomed to 65%, well above the threshold that often gets emerging market nations into trouble. The economic recession is deepening with GDP shrinkage accelerating.

The country, for the first time in ages can’t even manage a primary surplus (that is, your budget before interest payments). CDS spreads are exploding. The country’s exports for hard dollars, such as iron ore are collapsing in value thanks to the global slowdown.

Even if you thought the country was about to turn, its stocks aren’t cheap. This is no Greek sale. The median Brazilian stock trades at a – considering the situation – surprisingly high 14 PE ratio.

Brazil: The Investment Takeaway

For aggressive investors, Brazil is a perfect short sale, which can be played by shorting the Real, shorting individual stocks heading lower such as Petrobras or Vale (NYSE:VALE). I’m personally heavily short the country’s main ETF, EWZ.

A more sophisticated investor might try shorting Banco Santander Brasil (NYSE:BSBR) and buying the parent Santander (NYSE:SAN) since they’re both down around 40% over the past year and may diverge at some point.
For investors wanting to buy the dip in Latin America, Brazil is simply the wrong country. Better alternatives include Peru (NYSEARCA:EPU) with its 20% Debt/GDP rating and moderately growing economy. Mexico (NYSEARCA:EWW), also investment grade, is more insulated from regional troubles as its economy becomes ever-more tied to exporting goods to the US rather than South America in the post-NAFTA world.

For the closest Brazilian proxy, try Colombia (NYSEARCA:GXG) which remains the region’s fastest growing major economy. Despite being investment grade, having a market-friendly government, and continuing to grow GDP at more than 3% a year, investors have lumped Colombia into the same boat as Brazil pricing both commodity-exporting nations similarly.

Colombia does face, like Brazil, a massive slump in its exports and its currency has sharply devalued. Unlike Brazil, it remains comfortably in investment grade territory with a much more reasonable 40% Debt/GDP reading.

The economy is largely insular and never overly relied, like Brazil, on FDI to boom in the first place. And Colombia just announced a long-awaited peace deal with the FARC terrorists that (finally!) takes geopolitical risk off the country’s table.

Both Colombia and Brazil are down 47% over the past 12 months in dollar terms. The single largest position in my portfolio is long Colombia and short Brazil and I fully expect this will be my home run investment of 2016.
The possible resignation of Brazil’s economic “superman” will usher in the next chaotic break lower in Brazilian equities as the grand finale – a fiery bankruptcy/devaluation/government collapse – looms larger and larger.

Big Oil Is Changing It’s Mind

Oil drilling in AlaskaMy Comments: For me, economics is a fascinating subject. For you, probably not so much.

Environmentalists are cheering the announcement by Shell they are abandoning their efforts to drill for oil in the Arctic waters for which they own the rights. Some will attribute this to media pressure about the likely environmental costs, but I suspect the reality is an accounting issue.

Time and again, the human experience has been to adapt. More and more of us are living in cities, meaning we tend to drive smaller and more efficient cars. New sources of energy are coming along; wind power, solar power, and if a recent article I saw is to be believed, small scale fusion reactors.

All of this implies opportunities for the rest of us as we invest our money so that when the time comes for us to retire and stop working for money, there will be money somewhere working for us.

Nick Butler September 28, 2015

One hundred and fifty miles from the Alaskan coast lies what must be the most expensive oil well ever drilled. Shell’s decision to abandon the Burger J prospect, along with its entire Arctic exploration campaign, marks an outcome that many at the oil major must have dreaded since it bought the leases in 2008.

That is not because of the cost — enormous though it is — of setting up remote platforms and drilling into rock that lies beneath 140ft of water. Shell is reckoned to have spent about $7bn on the exploration effort; some estimates put the figure even higher. But its balance sheet is strong enough to absorb the loss.

Nor will the public ill-will generated by years of exploration in pristine Arctic waters last for ever. Indeed, for some senior executives at Shell, the prospect of success in the Arctic was more worrying than the possibility of failure. Building the permanent facilities needed for actual production would have been far more contentious than the limited (if sometimes hapless) exploration work. Among the people on record as opposing Arctic drilling is Hillary Clinton, the frontrunner for the Democratic nomination for president. That is a battle that Shell will no longer have to fight.

More worrying, from Shell’s point of view, is the prospect of a declining reserves base. In common with several of the other oil majors, it is pumping oil faster than it can book new reserves of bankable assets. This was the reason for pushing on in the Arctic against public criticism and deteriorating economic prospects for so long. If, as some of the company’s executives believed, the Chukchi Sea blocks held about 35bn barrels of oil, Shell’s reserve base would have been secured and much effort would have been devoted to winning hearts and minds and pushing down costs. As it stands, the reserve base will continue to decline. Shell’s $70bn purchase of BG Group, if completed, will bring access to some identified resources — for instance off the coast of Brazil — but the cost of development is high and success is very uncertain.

In the long run, this is little short of an existential challenge. Can the existing reserves base be replaced with resources that can be developed commercially? Or is a period of corporate decline inevitable? For the past three years Shell has failed to find sufficient resources to replace production despite heavy exploration expenditure. In 2014 it replaced only 26 per cent of its oil and gas production. Over the past three years the figure is just 67 per cent.

The problem is not a shortage of oil and gas. The problem is access. Over the past decade, according to the BP Statistical Review, global oil reserves rose 24 per cent, despite 10 years of growing production, and gas reserves climbed 20 per cent. But the majors do not have access to much of it. Saudi Arabia and Venezuela are closed to foreign ownership. Much of Iraq is a war zone and politics limits access in areas such as Kurdistan even for the boldest independents. Libya is in a state of civil war. Iran is walled off by sanctions, which the nuclear deal only partially removes. Russia is also subject to sanctions. There are significant volumes of oil and gas to be developed from shale rocks in the US and elsewhere but the economics do not look good at $50 a barrel.

For understandable reasons companies do not like the idea of shrinkage and decline. So acquisition becomes a powerful temptation. Those in the sector with cash and the ability to raise capital will now be in predatory mode. No doubt there are bargains — even if BG at the offered price is not one of them. But many are cheap for good reasons.

For all these reasons, some will wonder whether Shell’s retreat from the Arctic was premature. Exploration is a risky business, and first impressions can be misleading. Oil and gas might never have been developed in Iran, Alaska or the North Sea if the industry had given up after initial wells drilled were unsuccessful. A single hole in the ground tells you only about a narrow slice of geology within an area of thousands of square miles. The success of Eni, the Italian group, in the Barents Sea shows that the Arctic does contain resources. Were it not for the political uncertainty surrounding Arctic drilling, Shell might well have carried on.

Still, the Arctic debacle is a salutary reminder to oil majors that their old business model is reaching the end of its life. Change might mean a different energy mix — taking the lead in the global transition away from hydrocarbons. Or it might mean accepting new relationships with the state-owned companies that control the world’s remaining resources. Only one thing is certain — the oil majors will have to change, or accept decline.

The writer, formerly an executive at BP, is a visiting professor at King’s College London. He writes an blog

A Global Recession Underway?

rolling-diceMy Comments: The ability to accurately predict the future is something I cannot do; if I could, you wouldn’t be reading this blog post. On the other hand, I’m OK with saying an economic downturn is very likely already under way. The writer below suggests it will bottom out sometime in 2017.

So, do we all stay in bed under the covers or step out and try to make something positive happen? My gut tells me staying in bed is a colossal waste of time and so we might as well figure how to take advantage of whatever life offers us. I have plans in place so wish me luck. Please.

Heather Stewart September 9, 2015

A “hard landing” for China is likely to plunge the world economy into recession in the next two years, Willem Buiter, chief global economist at Citigroup and a former Bank of England policymaker, has said.

As the Federal Reserve in Washington prepares to decide whether to defy warnings of economic fragility and push up interest rates next week, a research note by Citi’s experts warns of a 55% probability of global recession.

They expect the downturn to be driven by waning demand from the fragile Chinese economy, which Citi believes is heading for a crash.

“We consider China to be at high and rapidly rising risk of a cyclical hard landing,” Buiter said in the note. “Should China enter recession – and with Russia and Brazil already in recession – we believe that many other emerging markets, already weakened, will follow, driven in part by the effects of China’s downturn on the demand for their exports, and, for the commodity exporters, on commodity prices.”

A global recession is usually defined by economists as an extended period of below-capacity growth. Citi puts global potential growth at 3%, but expects growth to “reach or fall below 2%” before bottoming out in 2017.

“We believe that a moderate global recession scenario has become the most likely global macroeconomic scenario for the next two years or so,” Buiter says.

Few other economists are predicting a global recession, and the mood among investors has calmed since August’s chaotic trading, when growing evidence of China’s slowdown sent shockwaves through the world’s financial markets.

But Buiter says: “Economists seldom call recessions, downturns, recoveries or periods of booms unless they are staring them in the face. We believe this may be one of those times.”

He is skeptical of Beijing’s ability to mitigate the looming crisis, after a series of panic interventions in recent weeks to stem stock price declines and boost growth, describing China as “a messy market economy of the state capitalist/crony capitalist variety, where policy ambitions are not matched with effective policy instruments”.

Citi cites the sharp decline in GDP growth among emerging economies; the downturn of global trade; and low commodity prices and inflation, as signs that China’s weakness is already rippling through markets, saying: “The evidence for a global slowdown is everywhere.”

Buiter fears that the authorities in developed countries are ill-equipped to respond, given that interest rates are already close to zero, and high debt levels mean governments are likely to be unwilling to offer fiscal support by loosening the public purse strings.

A growing number of analysts have added their voices to calls for the Fed to hold fire, as insurance against a global slowdown. The World Bank and the International Monetary Fund have both called for a delay to interest rate “lift off”.

Kaushik Basu, the World Bank’s chief economist, was quoted as saying: “The world economy is looking so troubled that if the US goes in for a very quick move in the middle of this, I feel it is going to affect countries quite badly”.

Buiter was one of the first members of the Bank of England’s monetary policy committee, from 1997, and later served as a professor at the London School of Economics, before joining Citi. MPC members will publish the minutes of their latest meeting on Thursday, revealing whether they have become more concerned about the state of the global economy.

A Painful but Healthy Adjustment

money mazeMy Comments: Reassuring comments here from a trusted thinker on the markets. No guarantees but if you have at least a 5 year time horizon, we will be OK. Just don’t get caught up in the media rhetoric and the pointing of fingers. Almost all of it is stupid, ill informed, and self-serving. Life happens, and this is normal. Which is not to say there are no ways to continue making money.

August 24, 2015 by Scott Minerd

The recent global equity market selloff reflects a long-awaited—and I believe ultimately healthy—market correction. A number of commentators speculated that after Monday morning’s sharp decline in U.S. stocks, the intra-day reversal indicated that we reached a bottom. In the very short run, I would agree. However, longer term, neither fundamental nor technical data support that we have reached the levels of capitulation associated with the end of a market correction.

One example is the Chicago Board Options Exchange SPX Volatility Index (VIX), often referred to as the “fear” index. While it spiked significantly higher, the VIX still failed to stay at the levels normally associated with capitulation like those experienced in 2011. Over the coming days I expect the market will try to find some short-term footing, but I doubt we have found a bottom yet. Buying risk assets now would be like catching a falling knife—if you do so you are likely to get quite bloody in the short run.

The market rout has spawned numerous news stories attempting to explain the source of the sharp declines in global equities. Many have highlighted the decline in emerging markets, which, on balance, have now officially reached bear market territory, given the over 20 percent decline in the MSCI emerging markets index since April.
Some markets have done much worse, especially when measured in U.S. dollars. Brazil is the poster child for the ravages of a full-fledged bear market. Even with the devastating declines, emerging markets have yet to show any signs of bottoming based on either economic fundamentals or market technical indicators.

While in the U.S. fundamentals remain supportive of continued economic growth, technical indicators point to lower prices in U.S. risk assets. Looking at the S&P 500, the sudden collapse in prices should provide near-term support, but after some consolidation I would expect us to revisit the lows and ultimately test the 1,820 level. A decline to 1,820 on the S&P 500 would represent a 15 percent drop from the peak, which would be a healthy correction in a long-term bull market. As this correction plays out, I would expect yields on below-investment-grade energy credits to widen by another 200 to 300 basis points. Other equity markets and higher quality credit assets are likely to sell off in sympathy as well.

So what is causing all of this turbulence? The source is the massive misalignment of exchange rates, which finds its roots in quantitative easing. Case in point, consider Japan, which has weakened its currency by over 50 percent against the U.S. dollar, while China, Japan’s largest trading partner, has basically pegged the renminbi (RMB) to the dollar.

Strains on the terms of trade between countries that have devalued and those that have not have built to the point that perpetuating these disparities is destabilizing to the countries that have staunchly fought devaluation. Witness China’s recent move to devalue the RMB versus the dollar, proving that artificial equilibrium is not only impossible to maintain, but ultimately disruptive to markets and economic growth.

Now we are facing the turbulent path to a new equilibrium. The coming weeks will be difficult and it is hard to hazard a guess as to when and how this will all end. Nevertheless, I place great faith in governments’ willingness to use the printing press. It is a handy tool to prop up asset prices and temporarily spur economic growth. For that reason I don’t see recession on the horizon for the G-7 nations or China either.

In time, policymakers will react. I would assume that the reaction time is fairly short. No one seems inclined to test the limits of how far asset prices can fall. Yet, given the current bias by the U.S. Federal Reserve to raise rates and the Peoples’ Bank of China to support the RMB, some more time will need to pass before more dramatic action is taken.

I would suspect that this will all climax by late October, but only time will tell. For the time being more downside risks remain. As I have mentioned before, cash is king, treasuries will outperform, and patience is a virtue. I don’t believe we have reason for panic, but complacency is dangerous too. Look for opportunities and more signs of capitulation.

US-Iran Treaty Can Send Oil to $40

oil productionMy Comments: I’ve already said that I much prefer a negotiated deal between adversaries than continued threats to bomb the crap out of them. In todays economic and political environment, that option poses too many risks that I’m unprepared to accept.

Here’s some economic thoughts about what might happen, now the deal is in place. Yes, Congress has 90 days to approve, and no, the oil industry will be unhappy, but it’s time to think what is best for ALL OF US, and not just the few.

by Barry Ritholtz – July 14th, 2015

While the world is distracted by the unending Greek saga (will it or won’t it leave the euro?) and the epic Chinese stock-market meltdown (and manipulation), something really important is going on. Three words sum it up: Iran and oil.

Negotiators have reached a deal with Iran to constrain its nuclear arms program. Despite the pessimism and outright fear-mongering, an agreement has been reached.

Don’t let China’s stock market and Greece’s debt melodrama distract you from paying attention to this issue — now that this deal is all but consummated, the repercussions are potentially enormous.

The agreement to end 13 years of sanctions against Iran over its nuclear aspirations is likely to be the defining foreign policy achievement of the Obama administration. Iran had opportunistically pursued its nuclear ambitions after 9/11, accelerating the program once its biggest regional enemy, Saddam Hussein, was removed by the U.S. military invasion.

Normalizing relations between one of the largest military powers in the Middle East and the major nations of the West is a huge, game-changing event. Iran’s ruling party wants access to global markets, technology and capital; Iranian youth would like access to Western consumer goods, culture and most of all, the Internet. How much any of these become part of the end result of a deal has yet to be determined.
What is perhaps most fascinating about this deal is the role and ambitions of China and Russia.

China’s motives are more obvious: It would like to blunt the projection of U.S. military power around the world, disengagement of the U.S. from Middle East politics and — most of all — a reduction of geopolitical tensions that tend to raise oil prices.
Russia’s interests are more complex, since it benefits from higher oil prices. Putting Iran’s huge oil production back on the market could exacerbate today’s global crude glut. Speculation that this will happen has already helped push down the price of oil, which has fallen by about a third in the past 12 months. Further signs of a Chinese economic slowdown also are weighing on crude prices.

Given the current situation, including sanctions against Russia for its role in destabilizing eastern Ukraine, one has to wonder what advantage there is for Vladimir Putin & Co. if Iranian oil begins to flow freely to the global market.

The Houston Chronicle quoted Neil Atkinson, an oil analyst at Lloyd’s List Intelligence in London, who observed, “It’s finally dawning on the market that the overwhelming weight of supply growth isn’t just going away… Iran is a huge factor. I can see $50 in sight for West Texas Intermediate [when a deal is reached].” Iran has 40 million barrels of crude stored on at least 23 ships that could be released into the market relatively quickly, the Chronicle added.

So what’s driving the Russians to be so cooperative? Perhaps the lessons of the 1980s are still fresh in Putin’s mind. What brought down the Soviet Union wasn’t the result of military failures or armed conflicts through surrogates. Rather, it was the economic might of the U.S. Supporting a huge military requires a large, efficient and productive economy and the Soviets simply couldn’t compete with the U.S. As much as former U.S. President Ronald Reagan is praised for the collapse of the USSR, Adam Smith deserves more credit.

The Russians may have figured out that fighting the American economy has been a losing game for them.

A peaceful, non-nuclear Iran might help to limit the U.S. presence in the Middle East, according to Gary Samore of Harvard’s Belfer Center. “The Russians don’t like to see the U.S. going around the world, bombing countries,” he noted.

Given the painful sanctions on Russia — and the related precarious economic state it is in because of much-reduced oil prices — greater cooperation between Russia and the U.S. could be mutually beneficial. Both want to see a defeat of the Islamic State. So does Iran. All benefit from a more stable Middle East, albeit for very different reasons.

Putin is smartly playing a long game. Lower oil prices will be painful in the short run for Russia. But an aggressive U.S., with an expansionist military around the world may be even worse. Hence, the surprising willingness of Russia to sign on to an agreement to lift sanctions against Iran.

The key takeaways of the deal with Iran is that it has the potential to lower energy prices, reduce tensions in an area fraught with conflict and create an opening for Russia to find a way to end the sanctions now hobbling its economy. A Russian economy that is better integrated into the world economy will have far better growth prospects.

It will be interesting to watch the contortions and hysterics among members of Congress opposed to the Iran deal. But as of now the critics of the accord lack a veto-proof majority. However much they might complain, it is likely to just be political noise.

Watch the price of oil. Consider what increases in supply and reduction of Middle East tensions do to its price. Then imagine what that could mean for the global economic recovery.

Here’s What the Next Recession Could Look Like

Bruegel-village-sceneMy Comments: There is no doubt that both politicians and financial people generate success by evoking fear in those to whom they are talking. Sometimes it’s legitimate, but much of the time its BS designed to persuade you to part with your vote and/or your money. What follows here is consistent with my belief that while there will be another downturn, it’ll be nothing like the last one.


Corey Stern Jun. 20, 2015

Since World War II, the average expansion period for US gross domestic product has lasted less than five years — and the current expansion is now in its sixth year. Does that mean we’re due for another recession?

The GDP slowdown in Q1 of this year had some economists fearing that a recession was near. But recent strong economic data has calmed those fears.

Recessions don’t just happen because they are overdue; they need to be induced by some event.

In a note Thursday, Dario Perkins of UK-based Lombard Street Research pointed to the stock bubble as the most likely cause for an upcoming “lesser recession.”

“Asset prices have risen sharply over the past five years in response to low long-term interest rates and aggressive central bank stimulus,” Perkins wrote. “This presents an important risk to the global economy, perhaps the most likely trigger for the next recession.”

He added, on a positive note, that unlike the most recent economic downturn, the next one would likely only be tied to stock prices. This is because while stock values have skyrocketed over the past few years, home values in developed economies have made modest gains. Though a stock market crash would be a bad thing, it wouldn’t nearly have the same effect on GDP a housing market crash.

Think dotcom bust, not global credit crisis

Perkins illustrated his point by comparing the effect on GDP from both the dotcom crash and the subprime-mortgage crisis. During the dotcom bust, which didn’t affect housing prices, GDP continued to rise for the most part in the quarters following the stock market peak.

He also pulls research from the Bank of England showing that credit trends, while very similar to the trajectory of the business cycle, have peaks that are twice as large and twice as long. The worst recessions are those that coincide with a credit crunch, as in 2009. But we are still in a credit upswing since then. In other words, the next recession isn’t likely to be accompanied by a credit bust, which will further mitigate the harm done.

The next downturn will also be protected by the still sluggish recovery from 2009. That is, there are fewer imbalances, less systematic risk, less household debt, and less bank leverage.

A more mild recession will be good for central banks that have limited tools left to respond to an economic crisis. Interest rates — already near zero — can only go so much lower, and a very high benchmark would be needed to justify restarting QE.

Perkins explains: Suppose, for example, the next recession is caused by the bursting of a bubble in equity prices. Would QE be able to reverse such a decline? And if central banks were blamed for causing this bubble, would they be willing to try to reflate the bubble with the same policy? Obviously we can only speculate about this, but it is clear both the Fed and the Bank of England were anxious to stop doing QE because they were concerned about its potential impact on financial stability.

In short, while Perkins thinks a stock market crash could cause a recession soon, the effects will be nothing like those felt in 2009.