Dr Doom unconvinced by rally

PUBLISHED : Sunday, 28 September, 2003, 12:00am
UPDATED : Sunday, 28 September, 2003, 12:00am

Warning of a potential stock-market crash, investment adviser Mark Faber says massive imbalances in the US economy could lead to a sudden loss of confidence in the dollar

Investment adviser Marc Faber is warning of a potential stock-market crash during the next two months. In the September edition of his investment newsletter, the Gloom, Bloom and Doom Report, the Swiss-born economist cautioned investors that the Wall Street rally which began last October may be about to end in tears.

He says massive imbalances in the United States economy, namely the trade deficit and budget deficit which amount to a combined US$1 trillion, as well as a cumulative fiscal and corporate debt amounting to 300 per cent of GDP, could lead to a sudden and decisive snap in dollar confidence. Although there is no immediate catalyst for a crash, he worries the high level of confidence among investors is a bad sign.

'I think that even the bears are bullish, and are bullish for no other reason than that the market is going up,' Mr Faber said in Hong Kong after a business trip to North America and Europe.

'This extreme bullish sentiment for me as a contrarian is negative.'

Mr Faber, who has cultivated a celebrity image among the investment banking community for his self-characterisation as Dr Doom, said the outcome could be either a 1987-style crash where the Dow fell 22.6 per cent in a single day, or a more mild correction which gives back much of the gains of recent months.

In his report he says: 'I concede that strength in the basic, mining, and energy shares could mitigate weakness in the financial, housing and other sectors of the market, such as health care, which is a reason why a correction instead of a crash remains a possibility, especially given the easy monetary policies of the US Fed.'

Any US crisis would have a knock-on effect in Asia, Mr Faber said in Hong Kong, noting that he recently scaled back his exposure to regional markets. He remains bullish longer term, but cautions Asia is still highly correlated to the US and would suffer during any market rout. He advises readers to sit on the sidelines for the time being and buy on market dips.

Mr Faber is renowned for his bearish views on the US economy, believing that the Fed's aggressive cutting of interest rates since the topping of the technology bubble has exacerbated, rather than helped resolve, the economy's underlying problems.

By slashing short-term interest rates 13 times from 6.65 per cent at the start of 2000 to 0.5 per cent this summer, the Fed had thrown accelerant on the country's growing economic imbalances, he said. One example was the credit-induced consumer binge. As Americans cranked up their spending on foreign-made furniture, plastic toys and electronics, the trade gap had soared to an historic US$500 billion annual deficit.

The policy, Mr Faber said, had had the effect of a wealth transfer as production shifted from high-cost US factories to low-cost centres in Vietnam and China. Normally at this point in the business cycle, consumers would increase savings and reduce debt levels.

Low interest rates were also fuelling what appeared to be a housing bubble. During the first half, total mortgage credit expanded to US$1.01 trillion (annualized), up 12 per cent from the previous year. This compared with $337.3 billion of total mortgage credit in 1997. The credit expansion had led to a 17-year high in new housing starts to an annualised rate of 1.82 million. Median home prices rose 9.8 per cent from August last year to US$177,500.

Mr Faber believes these ultra-low interest rates are part of a Fed strategy to support asset prices and stave off a default spiral that could spread like wildfire in the debt-laden economy.

'If you print money, most things will go up in domestic prices,' he said. 'If you throw money out of helicopters as [Federal Reserve board member] Bernanke suggested they do, obviously real estate and stocks will continue to go up.'

He warned the fiscal strategy was ultimately doomed to fail, pointing out it now takes US$8 of deficit spending to create US$1 in GDP growth.

Once the inflationary genie was out of the bottle, Mr Faber said, its effects could be hard to control. Rising prices for commodities, health care, insurance and energy were just the first signs that a return to the double-digit stagflation of the 1970s may be unfolding.

He believes the Fed has tried to manage inflation expectations by using rhetoric laden with references to deflation, as well as 'doctored' CPI figures that dramatically understate price increases. This expectations-management is important in maintaining dollar confidence and preventing a rout in the bond market.

'Rising interest rates will kill off the refinancing boom, which led to higher consumption,' Mr Faber said. 'This is negative for the economy. For me the most likely scenario is higher inflation, but no economic recovery. People always think weak economies have low inflation and the strong economies have high inflation - but in general the opposite is true.'

Mr Faber said the Fed's policies had set off copy-cat devaluations around the world as the US's trading partners tried to maintain their export competitiveness.

'The Federal Reserve action, the credit bubble, and money printing, will force other countries to also print money to avoid having a currency that appreciates dramatically against the US dollar, therefore I think all paper currencies will lose purchasing power.'

As the world's central bankers seek to devalue their currencies, Mr Faber said one outcome would be a dramatic jump in the value of all hard assets.

'I don't think anyone in the world wants a strong currency,' he says. 'Eventually, the dollar will decline in purchasing power, and goods will become more expensive, in particular real assets such as real estate, art and commodities, in particular the gold price.'

Mr Faber said that during his recent trip to the US the economy appeared to be humming along, but he cautioned that this was an 'Indian summer', or temporary reprieve from the coming blow-out.

He added that the rising real-estate market in the US and Britain, rising gold prices, and the dramatic decline in US bond prices this June were early warning signs of the loss in confidence in paper money.