Enzio's Clock

Background

1. The unimportance of Dubai in  absolute terms

The ever-erudite Financial Times (FT) of 28th/29th November told us just how unimportant Dubai is in absolute terms:

• Lehmans. The government of Dubai and its enterprises ran up debts of $80 bn; this pales in comparison to Lehman's liabilities of $613 bn;
• Loans. British banks account for 41% of the UAE's total borrowings outstanding, with Standard Chartered and HSBC being the most exposed. But for these two banks, their loans to the UAE account for 7% and 2% of their total loans outstanding, and
• Toxic pygmy. According to said FT, "Credit Suisse...assumes that European banks account for half of Dubai's debt, estimated at US$80 bn.  If they lost 50 per cent on their exposure, bad loan provisions would rise by 5 per cent next year, equivalent to a Euro 5 bn (US$7.5 bn) after-tax hit.  Compared with the $1,700 bn of toxic assets (that) European and US banks have wiped out in the credit crisis, that is a drop in the Burj Al Arab swimming pool."  In other words, the after-tax hit in Dubai would not even reach the equivalent of 0,5 per cent of the toxic assets that European and US banks wiped-out in the credit crises (yes: plural for "crises")! 

How to Save/Make Money Off This Idea

2. The importance of Dubai in relative terms

Despite such lilliputian dimensions, the small pebble - Dubai - caused large ripples in the cesspool of global finance.  The FT states that by the end of this week -

• the FTSE 100 had fallen by 2.3 per cent,
• the Nikkei had stumbled by 3.8 per cent,
• yields on US Treasury bonds had fallen  by 12 basis points, and
• yields on UK gilts had fallen by 9 basis points.

These severe stumbles occurred despite the banking system already being backed by the government; so, to state that Dubai is a 'passing squall" is - perhaps - dangerous, n'est pas?   Indeed, just how much more can the state support the banks during a second banking crisis, one perhaps triggered by Dubai/

In my mind, the real issue is that Dubai has unleashed fears that have been clouding the market's subconscious for some time.  In particular, that the Economic Time® remains characterized by an excess supply of goods, one that will continue propelling unemployment and thus political unrest in the West's democracies.  It is this moving out of denial into acceptance that caused last week's large ripples in the cesspool of global finance. 

From an economist's perspective, this excess supply of goods implies that profits have to stay low:

• revenues cannot rise if there are already too many goods out there;
• costs will be cut even more, implying more layoffs, and
• productivity has to suffer as fewer workers will provide fewer goods.

Indeed, a case could be made that during 2010 and the first half of 2011, inventory cycles - as opposed to demand cycles  - will dominate the economic and thus stock market headlines: factories will produce 'just in time" to keep inventories at an absolute minimum level.

So: if you accept that the Dubai has made markets move out of denial, and, instead, has made them accept the fact that the Economic Time and thus profits will remain bleak for some time, then Dubai is the trigger of further market weakness.

The other point supporting future market weakness  is that fear will override greed: funds will want to preserve their gains for the year. Thus, they will seek to lock-in profits this week by selling out their positions. Let's just hope that this does not result in a stampede for the exit!

3. How to Make Money Off This Idea

1. Always consult your financial adviser first.
2. Go short the US stock market, e.g. via an ETF which I own, SDS:US
3. Go short U.S. financial stocks, as they could be in for a second drubbing. I own SKF:US, another ETF
4. Buy gold as an insurance policy.
5. In the near-term, buy government debt on a two-week view. It, like gold, will represent a haven of safety.