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Stephen L. Martin
Edition 1 +44 (0)20 7460 4356
smartin@fairfaxis.com
THE GREAT DEPRESSION OF 2009?
For investors, and most people associated with the capital markets, 2008 was our Annus Horribilis. This is
a more painful affliction than its mistranslation would imply. It was a year when we went from fear of
inflation to fear of deflation. It was a year when most of the rules of the game were thrown out. The
concept of de-coupling, in economic parlance, and diversification, in asset management speak, were
dismissed by the markets with devastating results. Few escaped the storm of the century unscathed.
While the U.S.A. remained at the centre of the crisis, thanks in large part to the collapse of the Sub-Prime
market, Globalisation ensured that the contagion spread quickly. A near-collapse of the global
financial system impacts every sector and every country.
However, just as the damage was swift and deep, we are also in a race against time to prevent a
deflationary spiral brought on by a de-leveraging process. For many observers, comparisons to the
Great depression of the 1930’s are too tempting to ignore. How realistic is this comparison and are we
more at risk of talking ourselves into a self-fulfilling prophecy?
Fairfax I.S. PLC is:
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A member of The London Stock Exchange
A UKLA Approved Sponsor,
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January 2009 The Fairfax Monitor
London – Dubai – New York
www.fairfaxplc.com
Fairfax I.S. PLC
46 Berkeley Square
Mayfair
London W1J 5AT
Tel: +44 (0)20 7598 5368
Fax: +44 (0)20 7598 5369
Email: info@fairfaxplc.com
The aim of the monthly Fairfax Monitor is to provide our readers with an insight into the various issues that
are currently driving the world economy. We will be taking a top-down view and will draw information
from a variety of sources across a range of asset classes. In order to support our view, the research will
incorporate economic arguments in addition to technical analysis.
6
January 2009
www.fairfaxplc.com 2
The Fairfax Monitor
Stock market volatility peaked in October 2008 and, despite the S&P 500 Index falling to a new 11 year
low, has been in decline ever since. The bullish divergence suggests that an important low is not too
far off. We expect a return of the VIX to below 30 and to “normal” levels of volatility in due course. A
return to “normal” levels is necessary to re-build confidence in the capital markets.
The TED Spread, considered a key indicator of global financial risk, is in sharp decline after surging to
its highest ever level in early October 2008. A decline below 0.75 would return the spread to the levels
of August 2007 and before the credit crisis began. The TED is indicating a significant reduction in the
risk of a financial system collapse.
The VIX Index – daily 2006-2008
The TED Spread – daily 2006-2008
6
January 2009
www.fairfaxplc.com 3
The Fairfax Monitor
Further evidence of stability in risk perceptions can be seen in the contraction of the spread between
US Government debt and Corporates. While the evidence is weak it does support our belief that risk
perceptions are normalising. We also note the extraordinary declines in yields which could imply the
bond market has abnormally low inflation expectations.
The Gold price is often used as a barometer of inflation expectations and risk perceptions. Many were
surprised to see the Gold price actually decline at the peak of the crisis in October 2008. The best
explanation is that a flight-to-quality benefited the U.S.$ which is inversely correlated to the Gold price.
It could also be indicating lower inflation expectations. The 200 day moving average is in decline to
confirm the downtrend and the longer term momentum indicators suggest a resumption of the sell-off.
Expect a re-test of $700. A 2 day close above $932 would be needed to avert the bears.
US 10 Year Government Bond Yield versus US10 Year Corporate Bond Yields 2005-2008
Gold – Spot (US$) 2006-2008
6
January 2009
www.fairfaxplc.com 4
The Fairfax Monitor
The Baltic Dry Index is arguably the best leading indicator of global economic activity. It’s rapid and
steep decline, of more than 94%, throughout the second half of 2008 is truly extraordinary. The recent
sideways consolidation and recovery has broken the 7 month downtrend and may indicate a bottom
has been reached. A positive and sustainable rise in this index would likely indicate that the risk of a
global depression is abating.
The FTSE 100 is somewhat correlated to the S&P 500 but may have more weighting in both Financials
and Resources so would be a good indicator of developments in these key sectors. We note that
base-building continues with the index maintaining its position above the October lows. While there is
some resistance and we would need to see this breached on volume, the mere fact that stability has
returned to the markets is the first step in re-building confidence. We expect the base-building to
continue for now.
The Baltic Dry Index 2006-2008
FTSE 100 Index 2006-2008
6
January 2009
www.fairfaxplc.com 5
The Fairfax Monitor
CONCLUSION
The Great Depression of the 1930’s began with the stock market crash of 1929. The stock market
bubble was created through easy credit and a lack of regulatory controls, much like the current crisis.
The same easy credit conditions lay at the heart of the current crisis but there are some subtle
differences this time. Unlike the crash of 1929, this bubble was in the U.S. real estate market and took
several years to implode. Its effect was, arguably, more widespread thanks to the development of
financial derivatives and a globally integrated financial services industry. Both financial crises,
separated by nearly 80 years, spread through the banking sector and the financial system as a whole.
Bank shares were sold off and we witnessed a run on a UK bank for the first time in living memory,
which was exploited by the media. Trust quickly evaporated and greed turned to fear. All the
required pre-requisites for a panic were in place. A sell-off of assets backed by debt ensued and talk
of deflation emerged. Deflation is the most immediate threat we face in this crisis and it could easily
turn into a spiral that would be difficult to contain as negative feedback loops act as catalysts. The
markets, supposedly efficient and self-correcting, failed forcing intervention by the various authorities
around the world. Now as then, the global capital markets and the financial system needed massive
support to avoid complete collapse. For many it was too little, too late. Policymakers are now
attempting to get ahead of the crisis by avoiding the same errors which many historians attribute as
the primary cause for the depth and breadth of the Great Depression. However, while the authorities
may not repeat the same mistakes there is a real possibility that new mistakes are made.
This has been first and foremost a banking crisis. Just as this crisis began in the banking sector, so too
must it end there. We are unlikely to see any sustainable growth in either the economy or the capital
markets until we see stability in the banking system. There are some signs that the U.S. housing market
and the global banking system appear to be stabilising. Authorities around the world are invoking
both a monetary and fiscal stimulus in an attempt to prevent a deflationary spiral. We may be at a
point in the current crisis where we diverge off the path of a deflationary spiral that crippled the
economy of the 1930’s. However, if they are unsuccessful and a deflationary spiral ensues, there is
likely to be a rise in nationalism and protectionism as each country focuses inwards to solve its
problems. Globalisation would be in retreat and we would be on a new and uncharted path. We
should not forget that the Great Depression lasted 10 years and only ended with the onset of the
Second World War. The path we take is in the hands of policymakers. Let us hope that they are
better equipped to solve this crisis than they were at preventing it in the first place.
So, to answer the question posed on our cover “The Great Depression of 2009?” we offer a simple: we
don’t know. Nobody does. There is no doubt that we are as close to a depression as anyone reading
this has ever come. The parallels to the Great Depression of the 1930’s are compelling. The lack of
regulatory controls, easy credit and greed combined with child-like complacency to risk created a
once in a lifetime financial crisis. However, it was the policymaker’s reactions to the crisis that
exacerbated the downturn in the 1930’s. Policymakers are currently trying to avoid similar errors but it
is too early to tell if they will be successful. There is no doubt the global economy is experiencing the
worst synchronised downturn in the post-war period. Some of the economic and financial indicators
presented in our article imply that at the very least we are experiencing a respite from the panic that
gripped the world in 2008. A reduction in risk-aversion will likely see a correction in Treasuries and a
further compression in Government/Corporate yield spreads. If this is accomplished while the major
stock markets continue to base-build it would not be unrealistic to suggest the worst of the storm has
passed. Unemployment rates would continue to rise and the economy would still see a contraction
but these are lagging indicators and a new bull market could be born in the midst.
6
January 2009
www.fairfaxplc.com 6
The Fairfax Monitor
Fairfax Non – Independent Research DISCLAIMER
This note is a marketing communication and comprises non-independent research. This means it has not been prepared in accordance with the legal
requirements designed to promote the independence of investment research and is not subject to any prohibition on dealing ahead of its
dissemination.
This note has been issued by Fairfax I.S. PLC in order to promote its investment services. Neither the information nor the opinions expressed herein
constitutes, or is to be construed as, an offer or invitation or other solicitation or recommendation to buy or sell investments. The information contained
herein is based on sources which we believe to be reliable, but we do not represent that it is wholly accurate or complete. Fairfax I.S. PLC is not
responsible for any errors or omissions or for the results obtained from the use of such information.
No reliance may be placed for any purpose whatsoever on the information, representations, estimates or opinions contained in this note, and no
liability is accepted for any such information, representation, estimate or opinion. All opinions and estimates included in this report are subject to
change without notice. This [note] is confidential and is being supplied to you solely for your information and may not be reproduced, redistributed or
passed on, directly or indirectly, to any other person or published in whole or in part, for any purpose.
In some cases, this research may have been sent to you by a party other than Fairfax I.S. PLC and, if so, the contents may have been altered from the
original, or comments may have been added, which may not be the opinions of Fairfax I.S. PLC. In these cases Fairfax I.S. PLC is not responsible for this
amended research.
The investments discussed in this report may not be suitable for all investors. Investors should make their own investment decisions based upon their own
financial objectives and financial resources and it should be noted that investment involves risk. Past performance is not necessarily a guide to future
performance and an investor may not get back the amount originally invested. Where investment is made in currencies other than the base currency
of the investment, movements in exchange rates will have an effect on the value, either favourable or unfavourable.
Fairfax I.S. PLC is a company registered in England and Wales with company number 5496355 and whose registered office address is 7, Queen Street,
Mayfair, London W1J 5PB. Fairfax I.S. PLC is authorised and regulated by the Financial Services Authority whose address is 25, The North Colonnade,
Canary Wharf, London E14 5HS and is a Member of the London Stock Exchange plc.
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For the United States
This research report has been prepared in whole by foreign research analysts who are not associated persons of the member or member organization.
These research analysts are not registered/qualified as research analysts with the NYSE and/or FINRA, but instead have satisfied the
registration/qualification requirements or other research-related standards of a foreign jurisdiction.
This report has been prepared by Fairfax I.S. PLC for distribution in the United States by Fairfax I.S. (US) LLC to U.S. Institutional clients and is provided for
information purposes only. Under no circumstances is it to be used or considered as an offer to sell, or a solicitation of any offer to buy. The information
contained in this report has been compiled from sources believed to be reliable but, while all reasonable care has been taken to ensure that the
information contained herein is not untrue or misleading at the time of publication, we make no representation as to its accuracy or completeness and
it should be relied upon as such. All opinions and estimates included herein constitute the judgment of Fairfax I.S. PLC as of the date of this report and
are subject to change without notice. From time to time, Fairfax I.S. PLC, its affiliates, and any of its or their officers or directors may have a position,
manage a public offering, make markets or have other material financial involvement or otherwise have an interest in transactions in securities which
are directly or indirectly the subject of this report.
Fairfax I.S. (US) LLC accepts no liability whatsoever for any direct or consequential loss arising from any use of this report or its contents. This report may
not be reproduced, distributed or published by any recipient for any purpose.
Any U.S. recipient of this report that would like further information regarding any security discussed herein should contact Fairfax I.S. (US) LLC at 646-336-
4955. Furthermore, any recipient of this report that would like to effect any transaction in any security discussed herein should contact and place
orders with Fairfax I.S. (US) LLC at +44 20 7460 4360 or in the United States 646-336-4955, which without in any way limiting the foregoing, accepts
responsibility (solely for purposes of and within the meaning of Rule 15a-6 under the SEC Act of 1934) for this report and its dissemination in the United
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RESEARCH - The Fairfax Monitor - Edition 1

  • 1. Stephen L. Martin Edition 1 +44 (0)20 7460 4356 smartin@fairfaxis.com THE GREAT DEPRESSION OF 2009? For investors, and most people associated with the capital markets, 2008 was our Annus Horribilis. This is a more painful affliction than its mistranslation would imply. It was a year when we went from fear of inflation to fear of deflation. It was a year when most of the rules of the game were thrown out. The concept of de-coupling, in economic parlance, and diversification, in asset management speak, were dismissed by the markets with devastating results. Few escaped the storm of the century unscathed. While the U.S.A. remained at the centre of the crisis, thanks in large part to the collapse of the Sub-Prime market, Globalisation ensured that the contagion spread quickly. A near-collapse of the global financial system impacts every sector and every country. However, just as the damage was swift and deep, we are also in a race against time to prevent a deflationary spiral brought on by a de-leveraging process. For many observers, comparisons to the Great depression of the 1930’s are too tempting to ignore. How realistic is this comparison and are we more at risk of talking ourselves into a self-fulfilling prophecy? Fairfax I.S. PLC is: Regulated by the Financial Services Authority A member of The London Stock Exchange A UKLA Approved Sponsor, An AIM Nominated Advisor & Broker A NASDAQ Dubai Listing Sponsor January 2009 The Fairfax Monitor London – Dubai – New York www.fairfaxplc.com Fairfax I.S. PLC 46 Berkeley Square Mayfair London W1J 5AT Tel: +44 (0)20 7598 5368 Fax: +44 (0)20 7598 5369 Email: info@fairfaxplc.com The aim of the monthly Fairfax Monitor is to provide our readers with an insight into the various issues that are currently driving the world economy. We will be taking a top-down view and will draw information from a variety of sources across a range of asset classes. In order to support our view, the research will incorporate economic arguments in addition to technical analysis.
  • 2. 6 January 2009 www.fairfaxplc.com 2 The Fairfax Monitor Stock market volatility peaked in October 2008 and, despite the S&P 500 Index falling to a new 11 year low, has been in decline ever since. The bullish divergence suggests that an important low is not too far off. We expect a return of the VIX to below 30 and to “normal” levels of volatility in due course. A return to “normal” levels is necessary to re-build confidence in the capital markets. The TED Spread, considered a key indicator of global financial risk, is in sharp decline after surging to its highest ever level in early October 2008. A decline below 0.75 would return the spread to the levels of August 2007 and before the credit crisis began. The TED is indicating a significant reduction in the risk of a financial system collapse. The VIX Index – daily 2006-2008 The TED Spread – daily 2006-2008
  • 3. 6 January 2009 www.fairfaxplc.com 3 The Fairfax Monitor Further evidence of stability in risk perceptions can be seen in the contraction of the spread between US Government debt and Corporates. While the evidence is weak it does support our belief that risk perceptions are normalising. We also note the extraordinary declines in yields which could imply the bond market has abnormally low inflation expectations. The Gold price is often used as a barometer of inflation expectations and risk perceptions. Many were surprised to see the Gold price actually decline at the peak of the crisis in October 2008. The best explanation is that a flight-to-quality benefited the U.S.$ which is inversely correlated to the Gold price. It could also be indicating lower inflation expectations. The 200 day moving average is in decline to confirm the downtrend and the longer term momentum indicators suggest a resumption of the sell-off. Expect a re-test of $700. A 2 day close above $932 would be needed to avert the bears. US 10 Year Government Bond Yield versus US10 Year Corporate Bond Yields 2005-2008 Gold – Spot (US$) 2006-2008
  • 4. 6 January 2009 www.fairfaxplc.com 4 The Fairfax Monitor The Baltic Dry Index is arguably the best leading indicator of global economic activity. It’s rapid and steep decline, of more than 94%, throughout the second half of 2008 is truly extraordinary. The recent sideways consolidation and recovery has broken the 7 month downtrend and may indicate a bottom has been reached. A positive and sustainable rise in this index would likely indicate that the risk of a global depression is abating. The FTSE 100 is somewhat correlated to the S&P 500 but may have more weighting in both Financials and Resources so would be a good indicator of developments in these key sectors. We note that base-building continues with the index maintaining its position above the October lows. While there is some resistance and we would need to see this breached on volume, the mere fact that stability has returned to the markets is the first step in re-building confidence. We expect the base-building to continue for now. The Baltic Dry Index 2006-2008 FTSE 100 Index 2006-2008
  • 5. 6 January 2009 www.fairfaxplc.com 5 The Fairfax Monitor CONCLUSION The Great Depression of the 1930’s began with the stock market crash of 1929. The stock market bubble was created through easy credit and a lack of regulatory controls, much like the current crisis. The same easy credit conditions lay at the heart of the current crisis but there are some subtle differences this time. Unlike the crash of 1929, this bubble was in the U.S. real estate market and took several years to implode. Its effect was, arguably, more widespread thanks to the development of financial derivatives and a globally integrated financial services industry. Both financial crises, separated by nearly 80 years, spread through the banking sector and the financial system as a whole. Bank shares were sold off and we witnessed a run on a UK bank for the first time in living memory, which was exploited by the media. Trust quickly evaporated and greed turned to fear. All the required pre-requisites for a panic were in place. A sell-off of assets backed by debt ensued and talk of deflation emerged. Deflation is the most immediate threat we face in this crisis and it could easily turn into a spiral that would be difficult to contain as negative feedback loops act as catalysts. The markets, supposedly efficient and self-correcting, failed forcing intervention by the various authorities around the world. Now as then, the global capital markets and the financial system needed massive support to avoid complete collapse. For many it was too little, too late. Policymakers are now attempting to get ahead of the crisis by avoiding the same errors which many historians attribute as the primary cause for the depth and breadth of the Great Depression. However, while the authorities may not repeat the same mistakes there is a real possibility that new mistakes are made. This has been first and foremost a banking crisis. Just as this crisis began in the banking sector, so too must it end there. We are unlikely to see any sustainable growth in either the economy or the capital markets until we see stability in the banking system. There are some signs that the U.S. housing market and the global banking system appear to be stabilising. Authorities around the world are invoking both a monetary and fiscal stimulus in an attempt to prevent a deflationary spiral. We may be at a point in the current crisis where we diverge off the path of a deflationary spiral that crippled the economy of the 1930’s. However, if they are unsuccessful and a deflationary spiral ensues, there is likely to be a rise in nationalism and protectionism as each country focuses inwards to solve its problems. Globalisation would be in retreat and we would be on a new and uncharted path. We should not forget that the Great Depression lasted 10 years and only ended with the onset of the Second World War. The path we take is in the hands of policymakers. Let us hope that they are better equipped to solve this crisis than they were at preventing it in the first place. So, to answer the question posed on our cover “The Great Depression of 2009?” we offer a simple: we don’t know. Nobody does. There is no doubt that we are as close to a depression as anyone reading this has ever come. The parallels to the Great Depression of the 1930’s are compelling. The lack of regulatory controls, easy credit and greed combined with child-like complacency to risk created a once in a lifetime financial crisis. However, it was the policymaker’s reactions to the crisis that exacerbated the downturn in the 1930’s. Policymakers are currently trying to avoid similar errors but it is too early to tell if they will be successful. There is no doubt the global economy is experiencing the worst synchronised downturn in the post-war period. Some of the economic and financial indicators presented in our article imply that at the very least we are experiencing a respite from the panic that gripped the world in 2008. A reduction in risk-aversion will likely see a correction in Treasuries and a further compression in Government/Corporate yield spreads. If this is accomplished while the major stock markets continue to base-build it would not be unrealistic to suggest the worst of the storm has passed. Unemployment rates would continue to rise and the economy would still see a contraction but these are lagging indicators and a new bull market could be born in the midst.
  • 6. 6 January 2009 www.fairfaxplc.com 6 The Fairfax Monitor Fairfax Non – Independent Research DISCLAIMER This note is a marketing communication and comprises non-independent research. This means it has not been prepared in accordance with the legal requirements designed to promote the independence of investment research and is not subject to any prohibition on dealing ahead of its dissemination. This note has been issued by Fairfax I.S. PLC in order to promote its investment services. Neither the information nor the opinions expressed herein constitutes, or is to be construed as, an offer or invitation or other solicitation or recommendation to buy or sell investments. The information contained herein is based on sources which we believe to be reliable, but we do not represent that it is wholly accurate or complete. Fairfax I.S. PLC is not responsible for any errors or omissions or for the results obtained from the use of such information. No reliance may be placed for any purpose whatsoever on the information, representations, estimates or opinions contained in this note, and no liability is accepted for any such information, representation, estimate or opinion. All opinions and estimates included in this report are subject to change without notice. This [note] is confidential and is being supplied to you solely for your information and may not be reproduced, redistributed or passed on, directly or indirectly, to any other person or published in whole or in part, for any purpose. In some cases, this research may have been sent to you by a party other than Fairfax I.S. PLC and, if so, the contents may have been altered from the original, or comments may have been added, which may not be the opinions of Fairfax I.S. PLC. In these cases Fairfax I.S. PLC is not responsible for this amended research. The investments discussed in this report may not be suitable for all investors. Investors should make their own investment decisions based upon their own financial objectives and financial resources and it should be noted that investment involves risk. Past performance is not necessarily a guide to future performance and an investor may not get back the amount originally invested. Where investment is made in currencies other than the base currency of the investment, movements in exchange rates will have an effect on the value, either favourable or unfavourable. Fairfax I.S. PLC is a company registered in England and Wales with company number 5496355 and whose registered office address is 7, Queen Street, Mayfair, London W1J 5PB. Fairfax I.S. PLC is authorised and regulated by the Financial Services Authority whose address is 25, The North Colonnade, Canary Wharf, London E14 5HS and is a Member of the London Stock Exchange plc. . For the United States This research report has been prepared in whole by foreign research analysts who are not associated persons of the member or member organization. These research analysts are not registered/qualified as research analysts with the NYSE and/or FINRA, but instead have satisfied the registration/qualification requirements or other research-related standards of a foreign jurisdiction. This report has been prepared by Fairfax I.S. PLC for distribution in the United States by Fairfax I.S. (US) LLC to U.S. Institutional clients and is provided for information purposes only. Under no circumstances is it to be used or considered as an offer to sell, or a solicitation of any offer to buy. The information contained in this report has been compiled from sources believed to be reliable but, while all reasonable care has been taken to ensure that the information contained herein is not untrue or misleading at the time of publication, we make no representation as to its accuracy or completeness and it should be relied upon as such. All opinions and estimates included herein constitute the judgment of Fairfax I.S. PLC as of the date of this report and are subject to change without notice. From time to time, Fairfax I.S. PLC, its affiliates, and any of its or their officers or directors may have a position, manage a public offering, make markets or have other material financial involvement or otherwise have an interest in transactions in securities which are directly or indirectly the subject of this report. Fairfax I.S. (US) LLC accepts no liability whatsoever for any direct or consequential loss arising from any use of this report or its contents. This report may not be reproduced, distributed or published by any recipient for any purpose. Any U.S. recipient of this report that would like further information regarding any security discussed herein should contact Fairfax I.S. (US) LLC at 646-336- 4955. Furthermore, any recipient of this report that would like to effect any transaction in any security discussed herein should contact and place orders with Fairfax I.S. (US) LLC at +44 20 7460 4360 or in the United States 646-336-4955, which without in any way limiting the foregoing, accepts responsibility (solely for purposes of and within the meaning of Rule 15a-6 under the SEC Act of 1934) for this report and its dissemination in the United States.” The Company may distribute research reports produced by foreign broker/dealers. All research reports shall be written by analysts in Europe and the U.K. employed by Fairfax I.S. PLC who are independent of Fairfax I.S. (US) LLC. Under no circumstances shall Fairfax I.S. (US) LLC be in a position to or exercise influence over the activities of the “third party analysts” or over the content of any research reports.