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New crisis ahead? 5 things to watch

Thanks to confusion, shortsightedness and anger, global markets are on course to be wiped out by a third -- if we're lucky, renowned bear Bob Janjuah says. If not, expect markets to fall by half.

By Jon Markman

Bob Janjuah is back, and dude, he's not happy about what you've done to the stock market.

Then again, Janjuah is never really very happy. But now the great bear of the United Kingdom -- the chief market strategist at the Royal Bank of Scotland (RBS, news, msgs), to be exact -- is quite sure that stocks' bender over the past eight months is about to come to a terrible, concussive, tragic end. He's like a cop who wants to slap a DUI on your portfolio.

Should we care? Well, most bears aren't worth the kibble that's slipped into their cages at night. But give him credit: Janjuah is a little different. He made a sell-everything call on the global financial fiasco two years ago with impressive accuracy, and he hadn't been all Chicken Little about it for years before either.

His view now is almost as negative as it was back then on everything but gold. Here's why he believes the end is near, the markets could get cut in half and lumps of yellow metal will trump stocks and bonds.

Who and what matters now

Janjuah believes that only five things matter now: three players and two forces. The players are the private sector (that is, individuals), the policymakers (government officials and central bankers) and the financial sector (brokerages and big institutions). The forces are balance-sheet repair and growth, which can also be viewed as final demand.

• The way these forces and players interact will determine how the next act plays out. Let's take them one at a time.

Player 1: The private sector

First, Janjuah believes that individuals get it. He says they know they borrowed too much and are reacting by borrowing and spending less, and saving more. This is expected to be a multiyear trend in the face of employment and wage fears, volatility in the economy and confusing messages from policymakers (e.g., "We have a major debt problem, so go out and borrow more!").

He believes ordinary Americans are fed up with being taken for chumps and have lost faith in a system that is bound to tax them to restore losses at banks. All they see is that the policymakers and financial sector have looked after each other at the expense of the private sector. Indeed, they see no trickle-down to their lives from all the efforts taken so far, since they're not much invested in stocks, yet they sense there will be a big bill to pay anyway. As a result, Janjuah believes the private sector has changed its behavior, swinging toward prudence and precautionary savings, and away from the sort of spending that would juice earnings growth for retailers and manufacturers.

Naturally, some people -- notably 20- and 30-somethings -- will consume irrespective of their anger. So Janjuah will essentially be right only if people 40 and older make these behavioral shifts.

Player 2: Policymakers

The strategist observes that policymakers were "totally wrong" through all of 2006 and 2007, and most of 2008, then finally got it once Lehman Brothers collapsed. They then did a great job of averting a total global financial meltdown but are now reverting to type by persisting with a "systemic war footing" policy even though the war is over. Although they understand, deep down, that printing money will create a huge risk of another debt-fueled asset price bubble, they heartlessly believe that it's OK to ignore it for now.

"Central bankers . . . are relying on the old failed policy of more and bigger asset bubbles on the hope that it equates to real and sustained growth for the private sector," Janjuah says wearily. "This reckless policy is creating the mother of all bad balance sheets -- that of governments."

Janjuah believes there are two choices: the current path of more debt and more bubbles, which is the "worst possible outcome," as it will cause individuals to become even more cynical and thus withdraw more from spending -- or the path of austerity.

As you might imagine, he believes the latter will come, whether we get the former or not, and "the more we resist . . . the worse the endgame." He adds, "Everyone should hope that the great debasement experiment will be exited voluntarily and not forcibly" due to a citizen revolt or a dollar crisis. "Forcible exit is the path to another recession before the first one has been addressed, and it will be hugely difficult to emerge from."

Player 3: The financial sector

Janjuah believes the financial sector is largely confused at this point. On one hand, bankers and asset managers fear deep regulation and compensation restrictions, as well as demands to cut their balance sheets under threat of being broken up, taxed to death and vilified. But on the other hand, they are being allowed to use supercheap money provided by central bankers to bid up other financial assets. Moreover, banks are being told that they must cut balance-sheet risk while at the same time lend vigorously to the public, which is a contradiction.

He believes that going into 2007 and 2008, bankers were too greedy. By early this year, they were too fearful. Now they're too greedy and wishful again, as they are positioned to borrow and lend extravagantly to businesses despite real fears that genuine and sustainable growth is not likely without continued government assistance -- and that the public isn't buying, so any new inventory buildup will go down a rat hole.

Putting all the pieces together, Janjuah notes that the key issue now is whether policymakers' plans to keep printing money to solve the financial crisis will really work. Janjuah believes that the public has already determined the plans won't and that financial institutions are "hanging on by a few threads" after six months of weak economic reports that have been hyped by the media for being stronger than low expectations.

The strategist says his data show the coming retail season will demonstrate emphatically that the public is opting for austerity, causing the government to follow, basically by throwing up its hands and permitting a second round of recession. He thinks this is actually the "least bad" way out, because although it may take the global stock markets down 35%, the alternative -- more loose money and borrowed stimulus -- would take the markets down by half.

Janjuah had forecast early in the summer that the Standard & Poor's 500 Index ($INX) would reach the 1,100 level by early November in a reaction to the severe lows of March. But now he's forecasting a return to the mid-900s by the year's end and the low 800s by the end of the first quarter. He looks for investment-grade corporate and government debt to outperform, and prefers U.S. and German bonds to British bonds. As for currency, he pooh-poohs all of them and ends the tirade with: "Gold, please."

• If this all transpires as expected, Janjuah further forecasts that the public will come to see central bankers' currency debasement as a failed policy that must be punished -- the opposite of the current circumstance in which the policy has been given the benefit of the doubt. He then sees the potential for new lows in stocks, with the S&P 500 trading in the 500s while gold goes to $1,500.

The forces: Balance-sheet repair and anemic growth

From there, the great bear sees three to five years of government, corporate and individual balance-sheet repair in which U.S. and British gross-domestic-product growth limps forward at around 1% a year -- "a long period of repair and refueling." And just for good measure, Janjuah calls this the "least worst outcome" because he thinks it would be more catastrophic if governments responded with more policy measures that further prolonged the inevitable. For those who need to be in stocks, he recommends sticking to "hard-currency, strong balance-sheet" countries such as Australia.

Future news headlines, he forecasts, will feature battles between central bankers, who at least privately are hard-wired to fear bubbles and inflation, and fiscal authorities, who want short-tem fixes to retain their jobs. Americans could think of it as a "rumble in the jungle" between those like former Federal Reserve Chairman Paul Volcker, who have the guts to defy politicians and puncture bubbles, and those like fellow ex-Fed Chairman Alan Greenspan, who believe bubbles are innocuous.

These forecasts are not particularly outrageous. I've said all along that the Fed's policies are experimental and that we therefore don't really know what the consequences will be. My own expectation is that governments and central banks will be successful at refloating the financial system, as they did in 1991 after the last credit meltdown; that the credit bull market that started in the spring will drag stocks along, kicking and screaming; and that the global economy will grow at a measured pace over the next few years without suffering a renewed catastrophe. But I'm always willing to entertain the possibility that I could be wrong, and I do not dismiss Janjuah's apocalyptic views out of hand. At present, my loose stop (yellow flag) on funds is a monthly close under the 1,003 level of the S&P 500, and my hard stop (red flag) is 945.

Longer term, Janjuah adds that the crisis must end with a commitment by policymakers never to let the gross misallocation of capital seen over the past two decades occur again. And that is a fact.

"Wall Street must serve Main Street, and not the other way around," he says. "This is the clear lesson from the failures of the past 20 years." Amen.