A very cool, very clever black man overcomes racism and ignorance to triumph over his detractors thanks to superior intellect and a methodical nature. No, not the Presidential election, but the plot of the multiple Oscar winning movie ‘In the Heat of the Night’, which was released over 40 years ago but resonates today on the cusp of a generational political shift in US politics. Having watched it again at the weekend, and amid the endless stream of apocalyptic economic comment (I’m a longtime fan of NYU economist Nouriel Roubini, but he’s becoming the Henry Blodget of the bear case, and we all know how that ended), Americans can feel justifiably proud that in a generation we have got to this point. It looks increasingly likely that the Democrats will seize not only the White House, but a filibuster proof majority in the Senate as well, and that will have profound implications for markets in coming years. The Thatcher/Reagan paradigm of turbo-charged, trickle down capitalism is history, and rightly so given the catastrophic governance failures revealed this year and the dangerously wide income inequalities and frozen social mobility evident in the US. Indeed, the political fallout from the near collapse of financial capitalism will cause political shock waves worldwide, with rising extremism of a kind we haven’t seen in decades. Broadly, I’d expect the US to move leftward, while Europe shifts to the right. Countries like Austria, with an existing predilection for Neo-Nazis in Lederhosen, will swing further to the extreme right as their banking systems implode (Austrian banks have loans totalling 85% of GDP to slumping Eastern European economies like Hungary and Ukraine), and Italy won’t be far behind; Berlusconi may be ridiculous, but his successors are likely to be far more sinister, and a xenophobic anti-immigrant mood has already erupted. Economically, we are likely to see an increasingly cartelized world dominated by national and regional corporate champions 1970s style operating with a degree of competitive protection, rather than the free-wheeling world of global capital flows we saw in the last couple of decades. Interest rates will be remarkably low, sub 2% everywhere in the developed world and 1% or less in some major economies. Globalization as a trend is irreversible, as are the aspirations of hundreds of millions of Asians to adopt a Western lifestyle, but the pace of integration (from trade to FDI) will slow dramatically from recent experience. The net impact of this increasing ‘top down’ form of state sponsored capitalism, plus the huge fiscal deficits (we’re talking 10% plus levels) governments everywhere will be running, will be slower trend GDP growth, and ultimately higher medium term inflation once we get past the current debt deflation threat. The inflation outlook will be exacerbated by the impact of the credit crisis on investment in expanding resource production; from energy to food, planned capacity expansion is now shrinking rapidly (eg Canadian tar sands, Brazilian agriculture), driven by prices collapsing to sub marginal costs, and the lack of project financing. I was a consistent bear of the investment bubble in commodities earlier this year, but within 3-5 years, many commodities will likely exceed their recent nominal highs, this time driven by a fundamental supply crunch as the world economy slowly recovers. Wise investors, while focused on the near-term trading opportunities thrown up by the current extreme turmoil, will adapt their strategic road map for the new realities we face. Meantime, having warned in recent posts that the October 10 market lows would likely be re-tested, I’m closing my equity index short positions, and would expect a truly dramatic bear rally to commence soon. Equities are now discounting a 40% plus earnings decline, and on long term asset valuation measures like Tobin’s q, US equities have become historically cheap (although other markets like Japan are even more attractively valued). There may be another 10% downside on further liquidation selling near-term, but there’s easily 25-30% upside on major indices by year end as unsustainably extreme risk aversion, reflected in measures from the Yen to credit spreads, inevitably reverses. Those are the kind of odds I like.

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Austria, energy, Europe, food, Gdp, Henry Blodget, Hungary, In the Heat of the Night, Italy, Japan, Market Commentary, Nouriel, NYU, Oscar, Senate, Ukraine, United States, White House