Gavekal’s four scenarios for what lies ahead

Without a doubt we are facing some very uncertain times. In times like these various results must be sketched out and then a plan must be designed to allow for fairly smooth passage. I have my own scenario, but also find it important to understand what the majority is betting on. Not because it is right or wrong, but because this will help you understand and react to the crowd correctly. For instance, I have been watching this subprime mess for quite some time. For me to take a short position on real estate at the moment of my discovery would have had adverse results. However, knowing there was a problem, it did make sense for me to take a small stake (test position) at times when the real estate indexes were struggling to make new highs, or as the rumors/news were first coming out. Now that we are in the middle of the crisis, the full reward is minimized in relation to the risk I would have to expose myself to.

FT. Alphaville provides some commentary as to some possible outcomes.

click below for the full commentary and replies, an excerpt is posted below.

Gavekal’s four scenarios for what lies ahead

• Scenario 1: The Fed sticks to its assertion that the risks for inflation and growth are now in balance, does not cut rates any further and the US economy grows past its credit crunch. If this happens, it would be massively bullish for the dollar, massively bearish for gold and potentially bearish for HK and Chinese equities (which are now anticipating more rate cuts). It would also be very bearish for US Treasuries and government bonds around the world. Additionally, we would most likely see a rotation within the stock markets away from commodity producers and deep cyclicals (which have been leading the market higher for years) towards the more traditional “growth” sectors, such as technology, health care, consumer goods, and maybe even Japanese equities.
• Scenario 2: The Fed sticks to its guns, does not cut rates, and the US economy really tanks under the weight of the credit crunch. In essence, the US would move into a Japanese-style “deflationary bust”. In this scenario, equities around the world, commodities, and the dollar would collapse, while government bonds would go through the roof.
• Scenario 3: The Fed ultimately cut rates, but this fails to rejuvenate the system and get growth going again. This would likely mean stagflation. As such, gold and other commodities would do well, while stocks and the US$ would struggle. Excluding bonds, this is increasingly what the market is pricing in today.
• Scenario 4: The Fed ultimately cuts rates, and succeeds in reining in the economy. This would be good news for equity markets, commodity markets, and the dollar, but of course, terrible news for bonds.