Denial Disaster Destiny & The Man Behind the Curtain

Posted by Greg Weldon & Michael Campbell

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Michael Campbell: Greg, the Stock Market has been down 11 straight days in a row. How would you categorize the market meltdown we have witnessed here?

Greg Weldon: A normal bear market wipeout in percentage terms has occurred in this 11 straight days of collapse by the close August the 8th/2011 where usually a bear market crash takes months or years. As you know this scenario is exactly what we laid out in June when we said that the markets are going to have a really hard time dealing with the end of QE2. That the situation in Europe would become more serious when Italy got involved which is exactly how it played out. Italy is involved now.

You could see a scenario where the market gaps down tomorrow, has another big loss and then starts to  rally from there. Potentially even an intra-day reversal that gives you some kind of semblance of a pivot point. But I think that without the Fed in the US coming in aggressively with a QE3,  that is going to be problematic, I think we have lower to go medium term.

Qe2 worked in that it kept asset prices inflated or reflated. It didn’t work to the degree that it also inflated commodity prices, part of the reason the economy is now wobbling. One of those unintended consequences.

Sure, they could come out with Qe3, monetization or running the printing presses to quote unquote save the stock market here.  Primarily because that is the only area of wealth reflation that we’ve seen since 2007 when the crisis started. And I view this as a relapse of the same crisis. They haven’t fixed anything. Quantitative easing doesn’t fix the  housing market, doesn’t fix the labor market so you still have these underlying problems that need to be dealt with.

I think the fear would be, if they came out and announced another round of quantitative easing and it failed to stem the selling. That would be a worst case scenario. I don’t envision that but you’ve got to keep it in mind. The Fed doesn’t have unlimited bullets here. So if they extend another round of easing they have to make sure it is well timed. Its a tricky game to say the least.

Michael: Is the S&P Downgrade of US Debt a confidence, psycohological or financial issue?

Greg: All three. Its psychological and a confidence and financial issue and what’s important to keep in mind is this is symptomatic of the situation we’re now in. You have two things going on.

A. The Reality, the mathematic reality of the macro situation that the Global economy find itself in.

B. Then there is the perception of the reality, which until the last couple of weeks has been far different than the underlying realities have been  because of the ability of central banks to print money and keep stock markets, specifically stock markets from doing exactly what they are doing now.

So I think there’s a reality check here and the downgrade of the US credit rating means that you are now seeing that if you pull back the curtain and expose the wizard behind pulling switches, the underlying reality is that they have not done anything to address the real problems of the macro economy. Specifically in the US and that extends out into the Globe.

Michael: I heard President Obama’s speech today and also heard comments by Timothy Geithner. My goodness there was certainly no recognition of what the problem is. They are in public denial, and I suspect its more than that. They don’t seem to understand what you’ve just alluded to here Greg.

Greg: Its really mind boggling to see the level of anger, denial, shock even. How dare they downgrade us, but guess what, you just threatened to default on your debt!

Do you think you deserve to be pristine in terms of the ratings, of what your credit risk is.  It is what it is. We just saw how close to the edge we can come in terms of having to deal with that risk. I think that to be surprised, or even angered by this is ludicrous frankly.

Its been decades since we went off the gold standard,. Decades of complacency, decades of waving the magic wand, printing money and having everything be OK. That has run its course. If you want one simple fact thats anecdotal, yet glaring in how much it speaks volumes to that level of complacency, it is the fact that the US Congress just crafted a debt/deficit plan and then they take a 5 week paid vacation. They are vacationing when they are supposed to be there working on the details of how they are going to address this problem. To me that is a glaring example that exposes that they really don’t understand how serious this is. They have never been called to task like they are being called to task now. Now that the curtain has been pulled back,  the realities are evident, they are all taking a 5 week vacation.

Michael: You are alluding that they just don’t get the seriousness of this. We know the same thing occurred in Europe, people coming back from vacation to deal with the problem and even then some wouldn’t come.

If Italy goes or has a more severe problem,  if Spain goes will they have the wherewithal to bail those countries out?

Greg: Amazingly today the European Central Bank’s announced they are going to buy the debt of Italy and Spain, and they did  come in and buy some nominal amounts. I mean we are not talking Greece, we are not talking about Ireland or Portugal where they have bought roughly 74 Billion Euro’s worth of debt in this program and its sitting on there balance sheet now. These numbers for Spain, Italy and lets not forget Belgium are staggering. Huge. To think the ECB is going to have the mechanisms to this without having to sterilize it, in other words to drain that liquidity out somewhere without having to print new money is something the ECB does not do. I don’t see how it is supposed to work. I just don’t see it.

So when you talk about their debt that matures its now.  Between now and the end of next year, an 18 month window that began at the end June, when the numbers really start to stack up, in terms of Italy its average is 35 Billion Euros every month. Spain the average is 17 Billion a month. Same with Belgium. These are big numbers. To think that the ECB with have the wherewithal and the mechanism to buy the level of debt that needs to be bought is a stretch. They got a big bang for their buck today, the timing of their announcement was something of a surprise, but now they have got to follow through with action. It is going to be much easier to be said than done.

Michael: Its a big enough problem when Governments have a deficit that they have to borrow money to cover. This is a much much bigger problem because they have past borrowings coming due, 35 Billion a month that Italy has to borrow. Not for their deficit, for their debt thats coming due that was borrowed before the aging baby boom really starts costing their systems.

With that backdrop, what advice are you giving investors at this point?

The same advice I gave your listeners in June a year ago. Be with active managers that have the flexibility to be short. CTA types, we run a CTA here and knock on wood we had a great day today because we were short stock indexes. Its important to have that flexibility and to have that versatility to be able to deal with opportunities that present themselves.

For Stock investors only that are long this market that is just so tough because I think the market has much more reality to deal with. The question becomes how quickly does the Fed and other Global Central Banks come back into play. My thought process is its not going to go as quickly as it did last March of 09 because you have some problems with thinking that you can just print money to save Stock Markets. Printing money like that is going to have a knock on effect on commodities and how that impacts inflation in places like China. This is a great case in point where all of a sudden we are not as autonomous with our monetary policy in North America as we were in the past. Where China and our sensitivity to these issues actually matters. Political pressure that comes to bear on the Fed from Asia that could actually make a difference in terms of the timing.

Even worse than that, is the potential of the Fed coming in with another program to buy treasuries,  buy mortgages and pegging 10 year interest rates to bring mortgage rates down……. and it doesn’t work!!

It doesn’t work to address the underlying Macro problem. That could be a nightmare scenario.

However, if they come with a big enough package, they could save the Stock Market, which presents a possible buying opportunity for long term investors. The problem with that though is, this will lift everything and it will cost more to buy a loaf of bread, it will cost more to buy a gallon of gas, and this will put pressure on the real economy, consumers and so on and so forth.

There are unintended consequences of whatever they do from here.

Michael: In the political realm, when you look out at practical society and government, what are some of the scenarios out there?

That’s such great question Michael. The time for academic solutions that could actually work is 20 years behind us. It was 1990/1991 when they should not have done the things that they did. Especially those they did in 2000/2001 when dropping rates, monetizing debt, pushing out credit to the point where we can’t pay it back. The thing to do would be to let the markets find their own natural levels and deal with the pain.

The problem is we’ve reflated so many times, reflated so much that that pain would be unbearable. This is the situation we are in and this is why they will choose to print as much as they have to to try and bail out, paper over this problem.

The real fear though is,  as I said before, that the problems are so fundamental, that merely printing more paper doesn’t address the problem. It is the easiest solution to try and avoid the pain that is naturally felt throughout this entire cycle. The real academic answer is to feel the pain. The problem is as human beings its our instinct to avoid pain. So that’s the path they will take. The question becomes how will the markets react to that and you get back to gold. It brings you back to gold every time because this is the main dynamic. They will ultimately print more money and ultimately they will debase paper currencies by a greater degree and ultimately that will continue to support gold to higher levels.

Canadians have done well with commodity demand from China and India. You’ve spent a lot of time analyzing China. how will this central dynamic affect Canada?

Greg: This is part of the problem for the Canadian Dollar. When we spoke in June 2011 we had just gone bearish on the Canadian Dollar and it is actually on the verge of breaking down right here. At par 70 on the futures contract for the Canadian Dollar and Par 65  is the breakdown. You get down to 92 and how that might then impact the Canadian Stock Market, which is actually underperforming or outperforming to the downside, because this central dynamic does portend a demand side problem for commodities. You see it in industrial metals, you see it in the energy complex and so on and so forth.

At the same time lets keep in mind that people are talking about crude collapsing to $50. Well at any time before 2005, any time in history $50 would have been a record high. So these are the type of things you have to keep in mind too, what’s relative, where are we compared to where we were. If we collapse to $50, they print more money and oil goes back up and makes new highs, these are the kinds of scenarios.

The bottom line Michael, there is one thing that I can feel somewhat certain about. is that the volatility. The amplitude of the volatility will continue to increase.

Michael: How much should we look at the  last quarter of 2008 and the first quarter of 2009 for guidance on what might happen in the markets?

Greg: There is good guidance to be gleaned from that, depending of course on what the wild card is in terms of Central Banking. I think we went into a primary bear market in the beginning of  2007. If that is the case many markets, and this just doesn’t apply to the US, but in many many markets the rally since the low in 2009 has met fibonacci retracements of the loss and this is the second leg down in a primary bear market. Not to get too technical, but wave one was 07 to 09, wave two was the retracement to recent highs, and this is wave three which is supposed to be the most violent wave.

That doesn’t bode well for equities and commodities, potentially testing and worse the 09/08 lows.

Michael: I know this is a ferociously busy time for you Greg and we appreciate you taking time to give us your lucid point of view. Greg Weldon is one of the top analysts in North America, an analyst other analysts read to figure out what’s going on behind the numbers. You can reach Greg at Thanks a lot Greg.

Greg: My pleasure Michael.