Marc Faber released his October 2011 issue of the Gloom Boom Report. Faber’s report is a must read for macro investors and it is well worth the money.
Faber’s first major point is that Greece is somewhat of a red herring. The market dislocation in the summer of 2011 was largely blamed on Greece and problems in the European banking system. However, Faber thinks that the underlying problem may in fact be China. Several fund managers including Jim Chanos and Hugh Hendry have long talked about the property bubble in China.
“Copper and the S&P 500 correlate very closely whereby peaks and lows for copper tend to lead the S&P highs and lows by a few months. More so, nobody should believe that copper declined in two months by 28% just becauseof Greece. What I wish to say is that the sudden weakness (Collapse may be a more appropriate term) of industrial commodities, equity markets around the world and currencies of emerging economies/commodity producers occurred for other reasons than Greek insolvency. Most likely, all these markets are beginning to discount serious economic and financial problems in China.
Many economies and currencies are highly dependent on Chinese economic growth. Brazil, Australia and Canada may experience serious currency declines if Chinese commodity consumption experiences negative growth. In the past two months, the Brazilian Real has been smashed and the long term up trend may have been broken.
Faber does not rule out the possibility that emerging markets stocks could approach 2009 levels if China continues to slow.
“Aside from further weakness in industrial commodity prices, emerging economies‟ stock markets will tumble and approach the 2009 lows.”
Incidentally, the lows would be about 40% lower from current levels. As we can see the lows on the EEM were about $20 in 2009.
“I am not suggesting that I have abandoned my belief that investments in emerging economies will be more rewarding in the long-term than investments in the developed economies but for the next six months or so significant downside risk does exist (in the order of another 20% to 30% on the downside). I should also mention that if I am wrong about the view that the Chinese economy is decelerating more than is generally factored in by the markets then any rebound in emerging markets is most unlikely to bring about new highs.
Thus, the risk reward profile for emerging market stocks is out of balance since Faber does not see new highs any time soon even if China does not slow dramatically.
Faber also thinks that the China slowdown would be bearish for the currencies of Australia and Canada and he recommends that investors be long US dollars for the next few months.
Faber previously recommended that investors hold 30-40% equities but he now recommends that investors continue to lighten up.
I would on rallies – reduce the equity exposure to around 25% and increase the US dollar cash weighting.
Faber clearly sees more downside risk for stocks over the next six months and recommends the US dollar as a safe haven for the few months.