Interpreting Middle East Economic News and Analyzing Market Trends

Market outlook for the rest of 2015: How to make it through the chaos that lies ahead

Image Source: CNN Money

With the end of the third quarter quickly approaching, I thought that it is the right time to give an update on some of the recent news in financial markets and what it is signaling to us.  At the very least, we need to pay close attention to what is happening in the oil market.  I previously wrote about oil here and why I believe the price is headed much lower.  Today, however, there is not only evidence that oil is headed lower, but that nearly every other asset will be headed lower too.

Source: St. Louis Federal Reserve (click on image to enlarge)

First of all, if we take a long term look at the price of oil, you can see from the chart above, which goes back to 1990, that the upswing in oil before the financial crisis was an anomaly.  What’s also important to note is that the price started to collapse before the famed Lehman incident in 2008, meaning that the rapid collapse in the oil price was a warning sign to the market.  The price quickly recovered and hummed along nicely from 2010 to 2014 trading with a range of $80 and $110 until the price started to collapse again.  Traders and analysts who hoped for a quick recovery like we saw back in 2009 have now thrown in the towel as the recent rebound in oil was short lived.  Oil is due for another rebound soon, but the overall trend remains to the downside.  Traders looking to see oil trade above $80 will have to wait a long time.  Oil is not only headed lower, it’s headed much lower… $20 is a pretty realistic price.

  

The main reason for this outlook is because the world is experiencing deflation, which is only going to get worse once more and more people realize that the mountain of debt and derivatives outstanding is a ticking time bomb.  I go into detail on debt and derivatives in my book.  So then, what does this mean for financial markets going forward?  More importantly, what’s the best way to make it through the chaos the lies ahead?

  

I’ve put together a list of five investment ideas for the rest of 2015 as well as a list of investments to avoid (disclosure: I am not an investment advisor so please use this information as part of your overall decision-making process and discuss with your investment advisor as you see fit).  The list is based on my outlook for global deflation.  The early evidence of deflation taking hold on the global economy can be seen by;

  1. All the trillions of dollars in QE has failed to stoke inflation (central bankers have failed to create inflation);
  2. Falling commodity prices across the board (falling demand worldwide);
  3. Negative interest rates on bonds in Europe and Japan;
  4. Rising yields on junk bonds (flight to safety);
  5. Rising defaults (Greece and Puerto Rico are recent examples);
  6. Falling stock markets (China);
  7. A strengthening U.S. dollar and weakening emerging market currencies (flight to safety).

  

With this in mind, here are the top 5 investment ideas for the rest of 2015:

1. Cash is king (paper not digital)

People stand in a queue to use ATM cash machine of a bank in central Athens, Sunday, June 28, 2015. Greece is anxiously awaiting a decision by the European Central Bank on whether to increase the emergency liquidity assistance banks can draw on from the country's central bank. (AP Photo/Daniel Ochoa de Olza)

Image Source: thejournal.ie

The best performing asset (if you can call it that) during deflation is cash… not digital cash stored in a bank, but physical paper cash.  The Greeks found this out the hard way.  This phenomena, however, is not new and not unique to Greece.  People in Argentina, Cyprus, Ukraine and Venezuela have recent experience with this as well.  This trend will only increase and spread around the world as deflation takes hold.  People holding cash once deflation is over will be in for the bargains of their lifetimes as they will be the only ones able to buy anything.

2. U.S. dollar vs. GCC currencies as well as other leading currencies

Source: St. Louis Federal Reserve (click on image to enlarge)

Not only is cash king, the U.S. dollar is king too.  Forget about all the noise about how the U.S. dollar is losing its status as a reserve currency and all the talk of the trillions in U.S. debt.  The fact is that the U.S. dollar is by far the most widely used currency in the world.  In addition, most debt in the world is denominated in dollars.  Therefore, in order to pay off your dollar debt you have to buy dollars.  The U.S. dollar also enjoys its status as a safe haven currency, which can be seen today but its recent strength.   Deflation will only make dollars more valuable.  I expect the U.S. dollar to take out the high it reached back in the 1980s (see chart).  The dollar’s rise is only beginning.

 

What about the GCC currencies which are pegged to the U.S. dollar?  I believe that a strengthening dollar coupled with collapsing oil prices will put mounting pressure of GCC currencies to devalue or to de-peg.  Only time will tell…

3. Top rated U.S. dollar denominated sukuk from GCC issuers

Source: Markaz

Though the sukuk market remains small, GCC investors can benefit by owning income-generating sukuk from some of the region’s top issuers.  The issues to focus on would be U.S. dollar denominated and not local currency denominated such as UAE dirham or Saudi riyal.

4.  Income-generating real estate with top-rated tenants

  

The same goes here.  Income-generating real estate makes a lot of sense, but only if the tenants are able to pay you rent.  High-rise residential properties as well as class B or lower buildings will perform poorly.

  

5. Physical ownership of precious metals and stocks

  

Although prices of precious metals will decline during deflation, they will always maintain value and never go to zero.  They are also a great hedge against central bank stupidity.  The best way to own precious metals, especially during deflation is to own the physical metal and not an ETF or other paper form.

  

Stocks might seem like an odd one, but again, owning blue chip companies is also a good idea since they will maintain their value.  The overall stock market might decline by 50% or more, but the leading companies will decline less and will still be around after deflation ends.  However, be sure to hold the stock certificates directly as opposed to holding them in ‘street name‘.  Your stocks might survive a market crash, but your broker might not!

  

Here now are the top 5 investments to sell or avoid:

1. Off-plan properties and 2nd home vacation properties

Trump World Golf Club Dubai

Do I really need to say anything else here?!  Off-plan properties were a bad idea in good times, they will only be worse in bad times.  Many of these property developers will be lucky to make it through this time around.

2. Properties in high-flying markets

Source: The Telegraph

London, New York, Singapore and Dubai have been some of the best-performing property markets since the financial crisis.  All evidence is pointing to a slowdown in these markets with an eventual ‘correction’ on the horizon.  For those dead-set on getting into the property market now, wait!  If you can’t wait then look to income-generating properties with top-rated tenants over a vacation property.  There will be plenty of time to snap up that vacation home at rock-bottom prices in the near future (if you have the cash to pay for it!)

3. High yield bonds and emerging market bonds

BofA Merrill Lynch Junk Bond Yield Spread 2013 to July 2015

Source: St. Louis Federal Reserve (click on chart to enlarge)

There is clear evidence today that high-yielding bonds (which include junk bonds and emerging market bonds) are losing steam.  Investors are already getting out of them as their yields begin to rise.  This rise will only accelerate as deflation causes defaults to spike.  The trend today is towards AAA-rated bonds as can be seen by their extremely low yields (which are negative in some cases).

4. All IPOs and most stocks

Source: CNBC (click on chart to enlarge)

The Chinese just learned this the hard way.  Even with all the government intervention, the market continues to fall.  Investors are being wiped out by all the margin debt they took out.  There is still more room for the market to fall, but the story in China is much bigger than a crashing market.  China is one of the main culprits for the mess we are in today.  During the boom years, China built up massive capacity and bought up all the commodities it could.  Now that the boom has ended, commodity markets are waking up to the fact that demand is not coming back any time soon and all China has to show for it are empty cities and trillions of dollars in debt.  Expect other stock markets to follow the Chinese lead before the year ends.

  

5. Most currencies

Source: Yahoo Finance (click on chart to enlarge)

  

Emerging markets and commodity-dependent countries such as Australia, Brazil and Canada have realized that they in fact do not possess a secret formula to an economic miracle.  Instead, they were simply commodity producers for China.  Now that the game is over for China, currencies of these countries are quickly losing value.

  

Japan, however, is a special case.  It’s in a fiscal mess.  The country’s debt to GDP ratio is the highest in the world and its currency is losing value.  The country and its currency are headed for disaster.

  

I hope that this gives you some insight into where we are headed.  If you have any questions or comments, please use the comment feature below.