Market Overview

5 Bold Predictions for 2012, Black Swan to Trigger Unfortunate Events?

A black swan event, developed by Nassim Nicholas Taleb in his book The Black Swan, is a metaphor that explains in logical hindsight the reasoning to an unexpected event which has a major impact on society but should have been foreseen.

Developed nations saw a black swan event – the 2007-2008 global financial crash – where the likes of AIG, Bear Stearns, Lehman Brothers, Fannie May, and Freddie Mac all collapsed under the immense pressure of a liquidity crunch.

There are many theories flying around claiming of another upcoming financial crash. Some of these theories include a collapse of the Euro Zone and a possible break-up scenario and another Greek default.

Others state an inevitable rise in interest rates, as many central banks around the world have interest rates artificially low, let alone the real interest rate close to negative. The event to trigger this would be rapid inflation, which leaves central banks no choice but to raise their rates.

Feeding into this, domestically, the United States has expanding government debt, which cannot come to terms on how to combat it, and many different forms of quantitative easing both domestically and from abroad.

The following are five predictions of the events, which could be seen in hindsight as a black swan event:

1. Chinese GDP to Grow Sub-8.5%

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Chinese manufacturing slowed down in November, as China's official PMI – the index that tracks purchasing managers' activity in the manufacturing industry – slid to 49 from 50.4 in October. This means that it slipped from a level of mild growth to a decline.

A reading above 50 indicates expansion in the sector and below 50 indicates contraction. Some economists believe last week's reduction in China's reserve ratio may signal concern that a slowdown in the world's second-biggest economy is deepening. Most of the slowdown will come from the crisis in Europe.

A lot of China's growth is from its manufacturing sector, and as it slows, so does the economy. The Chinese economy is currently estimated to grow between 9% and 9.5% in 2012 from 2011. Look for the People's Bank of China to cut its reserve ratio a couple more times in 2012 in an attempt to spur economic growth.

2. S&P 500 to Fall Over 25%

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Considering all the uncertainty and problems throughout the developed economies, the S&P 500 is only down 0.34%. If at the beginning of 2011 you had told me that the United States would lose its “AAA” credit rating, that QE2's end would have negative effects, that Japan would endure a massive earthquake, that Europe would have a host of problems, and that the U.S. equity markets would be flat on the year, I would have said you were crazy.

Since none of the debt problems in the United States and in Europe have been resolved, the risk for a black swan event is possible. Europe already had to rescue Ireland, Portugal, and Greece, and almost saw the same with Italy and Spain. Also, S&P Ratings recently placed 15 Euro Zone nations on review for a possible downgrade, including Germany and France.

For a technical perspective, the S&P 500 continues to trade below its 200-day moving average, which can be seen as bearish as the Index tries to push, but cannot hold above it. Within the last four months, the S&P 500 has been forming a diamond pattern, which is usually a continuation formation. On a weekly timeframe, the S&P 500 came off its 2011 high in April and has been moving lower, so the continuation pattern should cause markets to move lower. The projected 25% move lower would bring the S&P 500 down to the July 2010 lows of around 1000.

3. U.S. Dollar Index to Rise over $85

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As equity markets around the globe begin to fall as the problems in Europe and the United States continue to unfold, investors will flock to non-risky assets like Treasury Bonds and the U.S. Dollar.

The U.S. Dollar saw an all-time low of $72.86 back in April of 2011 just as U.S. equity markets were topping. Since then, the Dollar Index has moved over 7.5% higher, currently trading around $78.44.

From current levels, a move to $85 is another 8.4% away. This means the entire move for the U.S. Dollar Index from its all-time lows is only 50% completed. When U.S. equity markets bottomed in 2010, the Dollar Index was trading around $88, so there is a chance if equity markets fall.

4. ECB to Cut Rates Below 1.00%

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During the decline in global equities, the European Central Bank will try to spur growth and investment by lowering interest rates, as the United States cannot lower rates any further.

Currently, the ECB has rates at 1.25%, whereas the United States has interest rates at 0.25%, the Bank of Japan at 0.10%, and the Bank of England at 0.5%. So the only potential worthwhile cut left is at the European Central Bank.

5. More QE or Rescue Packages

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As investors continue to flock to a risk-off trade, along with cuts in interest rates, U.S. Dollar swaps, and banks' reverse ratios are not effective, global leaders will have to use more fire power in terms of quantitative easing or some sort of rescue package.

This could come as another, much larger “Operation Twist,” or a package like QE1 or 2 was, just a bit beefier. This will cause risky assets to spike dramatically higher for a few weeks before slightly selling off as investors let the event marinate in their heads. After markets calm down with a slight pull back, most risky asset classes should rebound slowly as economic activity in developed markets slowly improves.

Hopefully these events do not unfold in 2012, but they are possible. Investors can only hope for economic and political leaders around the globe to resolve debt issues in their respective nation.

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