The US Government-bailout rally looks set to continue this week, putting a further lid on oil prices and keeping the dollar stronger. This is good news for emerging markets, where stocks should get a continued lift from increasing risk appetite. Indeed, the heavy selling by foreign investors in emerging markets has abated somewhat in the past week. Passage of a housing bill by Congress will inject further confidence that the US housing market could find a bottom, and that the safest credits, ie US Treasuries and Freddie and Fannie debt, are still safe. Financial stocks may also gain amid signs that their dubious assets, and maybe even some they wrote off, will start turning around. Liquidity may also improve as banks start to regain courage about trading securitised loans.
In addition to the Bernanke/Paulson put on financials, the SEC appears likely to add its own support by extending its restrictions on short-selling. The restrictions have already sparked a massive spate of short-covering - investors buying back the shares they borrowed in order to sell - providing its own lift to the market. With some faintly positive numbers on consumer sentiment emerging, some are beginning to wonder if the US just might escape the credit crisis without actually going into a technical recession after all. But the triumphant bear economists tell us it is a strange world when government bailouts are taken as good news. The seizure of two more banks over the weekend is just another sign that Phase Two of the credit implosion is underway and that the cost to the US taxpayer - and the toll on the US dollar - is just beginning. Banks are hurting so bad they are now tightening credit to healthy businesses, a trend that is likely to hurt capital expenditure, starve companies for working capital, and exacerbate job cutbacks and corporate bankruptcies. For the housing bill to work, moreover, will require even more write-offs by lenders as part of efforts to refinance homeowners. One also has to wonder what will happen once the short-covering is completed and the market loses that support.
The upshot is to expect increasing volatility in financial markets as investors look for technical buy and sell signals or (over)react to news developments. Rumours are already gaining a greater following. And with increasing regulation - and recriminations - over who is to blame for the mess in the US housing market, expect more lawsuits. If only there were an ETF for litigation. The problem with the bull thesis is that stock markets are now reacting to a falling price of oil, which is falling because oil markets believe that economic growth is going to continue to get worse. Bad economic growth is not good for stocks, and so it does seem that the new-found faith in equities is misplaced. It remains to be seen, moreover, whether oil's decline is merely a slight correction or the beginning of an about-face in long-term pricing. American demand for gasoline has in the past seemed fairly inelastic - suburbanites have to commute - but new statistics show that in the past seven months Americans have cut back so severely on the amount of miles they drive that the reduced toll collections is putting a dent in motorway maintenance funds. Semiconductor makers are reportedly shifting to solar power.
So if US oil demand drops, the question is to what extent slowing economies in emerging markets, especially China and India, will be making up for the drop. The prospect for that demand to continue rising looks pretty good. Keep in mind that no one is talking about recession in the emerging markets. And car sales are booming. Moreover, fuel prices are kept artificially low by government subsidies, encouraging drivers to do just the opposite of American motorists and drive more. Asia and the Gulf have plenty of cash to keep pouring into the gas tanks of their new middle class. So while oil may fall, it doesn't seem likely that it will fall very far.
Money, therefore, continues to flood into the UAE, with the World Bank putting the total at $19.4 billion in the last three years. That's a boon for local banks and for real-estate agents: with money comes expats, with HSBC ranking the UAE behind Singapore as a most desirable destination for the global class. Just to boost the exodus, the Sunday Times of London last week ran a huge special section on the UAE. But the biggest game in town may actually be finding a way to get money out. Gulf investors continue to look for ways to diversify out of the Gulf and the West, with Emaar announcing an Dh8bn dirham investment in Indonesia.
That means less of the dollars that the US shipped offshore for oil and teddy bears is going to find its way back into the country in the form of investments into the country's ailing financial sector. Emerging market central banks and sovereign wealth funds do, to some extent, need to continue to pour money into US assets - no other market is large enough to accommodate the kind of cash they need to stash. But the weakening US financial situation and the long-term decline of the dollar are hastening the urge to diversify their fellow, fast-growing emerging markets. For them to continue bailing out their US dollar investments, they would need to have greater confidence in America's prospects and a better return for their risk - sweeter deals and more control. That's something US legislators are unlikely to want to give. Expect, also, more aggressive GCC investments into oversees food supplies. This is part of a growing trend of resource nationalism by emerging market investors. China will invest in supplies of metal and oil, the Gulf in water and food. This will require they also beef up the ability to protect these investments from nationalisation by building out their military capability. While oil exports are an excellent lever, they are unlikely to protect Gulf farmland in Turkey or Sudan from populist politics. @Email:warnold@thenational.ae
