While stocks closed out the first quarter of 2013 on record highs, the outlook for rest of the year is very much in question. Global economic headwinds are intensifying and investors may be looking for any reason to take profits before uncertainty takes over. In our latest interview with demographics and economics prognosticator Harry S. Dent, Jr., we discuss where the trigger for his expected second-half downturn may stem from. Europe is the front runner, but China, the emerging markets, and even the U.S. present strong cases as well.
Dent is the author of The Great Crash Ahead: Strategies for a World Turned Upside Down, and editor of the free newsletter Survive and Prosper. You can read our previous interviews with Dent here, and learn more about his work at www.harrydent.com.
EQ: What were your thoughts on the Cyprus bailout and the tax on depositors to help fund the deal?
Dent: This is what happens when a country doesn’t have a printing press. They have to actually pay for their debt. The ECB is printing money in Europe, but individual countries have to go through certain austerity measures to qualify. So to get a bailout, they had to come up with some money, and particularly in Cyprus, it’s a money center. Their banking system is about eight times their GDP because places like Luxembourg and Malta. They take a lot of deposits from foreign investors. It’s almost like a little tax haven or money laundering system. So there’s not a lot of empathy in Germany or in Northern Europe to save Cyprus.
They’ll bail them out, but Cyprus needs to come up with $7 billion. They really didn’t have choice because at times like this they can’t really just levy a tax on citizens and tell them all to send them a check. So they just took it out of their bank accounts.
You have to be thinking that sooner or later, if other southern European countries get in trouble, that’s the easiest way to do it. So if you’re a rich person or a business in those countries, why would you have more than $100,000 sitting in a savings account? I’m surprised the markets didn’t react more to this.
The market just wants to go up, and it’s all stimulus money pushing it up. But really, this sets a precedent, and it just shows that Europe isn’t out of the woods yet. It still is in a recession and has major problems, but the markets are just acting like it’s no big deal. I think Europe’s probably the number one thing that can sink the markets later this year. We’re looking for a top probably around the summer—1600 on the S&P 500 give or take—and I think bad news out of Europe is probably the single most likely thing to trigger the next market correction.
EQ: The concern that a similar model could be used in future bailouts rattled the markets. Based on the approach that the U.S. government has adopted so far, do you think bail-ins would ever be possible here?
Dent: No, they’re not going to do that here, but you do have to realize that they’ve already in a sense done this. A number of people pointed out recently that if you look at the fact that the U.S. government and the Federal Reserve with its quantitative easing policies has literally pushed short-term and long-term interest rates for savers and investors at least 200 basis points, or 2 percentage points below what they’d be with present inflation, which averages at about 2 percent. So basically, a short-term T-bill should be yielding 2.5 percent, but you get zero right now. A long-term bond should be yielding 3.5 to 4 percent, but you get 1.5 to 2 percent. So they’ve basically been taking money from savers at maybe 2 percent a year for the last four years plus. When you compound that, in a sense, they’ve confiscated close to 10 percent of savings and money market accounts.
They just did it in a less obvious way, but it was a similar tax. Savers and anyone who owned a bond, or had a money market or savings account, has basically probably lost at least 2 percentage points a year for four years. That’s about 9 to 10 percent compounded.
EQ: Some light has been shed on China’s economic bubble recently and the country’s over constructed ghost towns. How bad is the situation there, and how do you see that affecting the rest of the global economy if it finally bursts?
Dent: One of the things that will be talked about in the April issue of my newsletter is that one of the things that people aren’t noticing is what’s going on in the emerging markets. Everyone knows about Europe and that it’s in a recession, and it doesn’t seem to be getting a lot worse but it’s also not getting better, and it should’ve by now. But emerging countries, if you look at the iShares MSCI Emerging Markets Index (EEM), it peaked back in April 2011 and has underperformed the rest of the markets. It’s not going to new highs like some markets in Europe and most of the indices in the U.S. are doing. The reason for this is that a lot of those countries are commodities exporters, and that’s the strongest part of their stock markets. Well, commodities prices also peaked in late April 2011, so the emerging markets are slowing. Their exports are slowing, and a lot of people don’t realize that our quantitative easing policies in the U.S., Europe, China and Japan, affects these emerging countries.
It tends to push our currencies down and theirs up, and it tends to push inflation up. You have to remember these emerging countries are fighting inflation while we’re fighting deflation. So it slows their economies, and when their economies slow, they’re the biggest demand for commodities since they’re so commodity intensive, so commodities prices go down. China’s exports also slow, and right now, China exports more to emerging countries than they do to developed countries. Their exports are slowing, and China imports a lot of commodities to feed those manufacturing exports.
We have kind of a vicious cycle where the commodities prices have peaked. It’s a 29 or 30-year cycle that we expected to peak in 2010, and it actually peaked in mid-2008, and then secondarily in early 2011. We think commodity prices will continue to go down, and as emerging countries slow, that will slow China. China has inflation that they’re fighting, but more importantly they keep having to fight their property bubble. China is extreme. The top 10 percent of people in China own just about all the real estate. They save more than we do, they invest, and they love real estate. They pushed real estate to absurd prices. I’m talking about 40 times income for cities like Shanghai, Hong Kong, Shenzhen and Beijing, so they do have a bubble. Every time their economy starts growing again, the bubble comes back and the government has to put in place higher down payment requirements, especially for second home purchases. They have to do things to fight that property bubble.
Sooner or later, that property bubble is going to burst. The top 10 percent of consumers in our country control probably about 40 to 45 percent of the spending. The top 10 percent of China controls 60 percent of spending. So China is really going to feel it when that bubble bursts. If these people get hit by a property bubble first, China’s economy is going to get hit. We do not see a soft landing in China. It may be the last economy to fall, but when they do, it’s going to be hard. Now, it’s also possible that these emerging commodities prices keep sinking. Copper, for instance, is at a very important point, which we discussed in our last newsletter. If it breaks below $3.40, it’s going down, and copper is the bellwether commodity.
If commodities keep collapsing, these emerging countries are going to keep slowing, and their exports will keep getting hit, and China will keep getting hit. So it’s not out of the possibility that China and the emerging countries could actually trigger the next global slowdown instead of Europe, or the United States. Therefore we think what’s happening in China is important, and we’ve said for years now that China has the biggest bubble, especially in real estate, across the economy. The government’s been building tons of stuff for nobody: Roads, infrastructure, bridges, commercial real estate, factories, railways, and especially low income apartments. They have an astounding amount of overbuilding in residential real estate, and at some point that bubble is going to burst.
EQ: You noted that China’s slowdown has likely played a role in gold’s lackluster performance against the backdrop of very aggressive stimulus programs from global central banks. How has the over speculation of gold played a factor in its distorted pricing?
Dent: One of the things people do is they see all this money printing and that’s just a goad for gold and silver. So we saw a major spike in gold and silver in 2011. Actually, silver spiked first and peaked in April 2011. We gave a big sell signal there when it hit $50 and it started to crash. Gold spiked in September and peaked a little later, but that was a big spike, and that was it. That was hedge funds, traders, people on leverage buying gold just like they speculated in oil in 2008, and when that bubble burst, it fell from $147 to $32.
Now gold and silver have gone nowhere since. Gold has been moving sideways between $1520 and $1800 for over a year and a half now. It’s going to break up or down out of that channel. If it breaks down, it’ll just be a simple explanation. It’ll just be margin calls. Yes, it’s supply and demand, but when you get that much speculation by highly leveraged hedge funds and traders, which we have tons of now, when something goes against them, they have to sell. It’s not a matter of holding it when it’s down. You have to sell when there are margin calls. That’s what happened to oil. I’ve never seen a market go down faster in that short of time than oil. It went from $147 to $32 to something between four to five months in late 2008.
So if gold breaks below $1520, it could be at $1250 in no time. Ultimately, we think gold is going to go back to $250 to $400 or something. It’s the same with silver. If silver breaks below $27, it could drop substantially. Copper is also the same thing. So it’s going to be interesting to see over the next several months whether commodities, especially if gold and silver breaks out of this. If gold breaks out of this it could be at $2080 in no time. So we have to see. It’s not really clear yet, but the gold chart to me looks like we should see an advance because we had a strong spike. When you have a strong spike, like we did in 2011, and then you trade in a sideways channel, nine out of 10 times, the chart is going to break up out of that channel. If gold does break up, it means you’re going to have some sort of financial crisis starting to build or countries getting desperate and printing more money because the economy is slowing in the emerging world or in Europe, or even in the U.S.
The economy has not felt all the tax hikes and government spending just yet. In the coming months, it could feel that. It’s about a 1.5 percent drag in GDP growth, and we’ve only been growing at 1.5 percent in recent quarters. What happens when the U.S. is looking at zero to 1 percent growth months from now, or Europe slips into a deeper recession, or these emerging markets and commodities prices keeps falling, and China keeps slowing? You’re just going to see countries ramp up more stimulus, and gold’s going to like that.
But we’ll have to see. I’m a little agnostic about gold right now because it is extremely oversold, the most of any sector that we study near term, and it should be bouncing stronger than it is, especially with the U.S.’s strong QE, China stepping up QE, and Japan just going nuts. They’re using the same word: “unlimited” bond buying and money buying. They’re going to do anything to create 2-percent inflation to deal with their dead, deflation economy. So that’s yet to be told. My guess is gold is likely to break up, not down, but then we’ll be telling people to sell because I think the next rally in gold is probably its last.