Avoiding The Abyss.(Global Investor)(economic recession)

Byline: Barton Biggs; Biggs, the famed Wall Street strategist, is a managing partner with Traxis Partners hedge fund in New York.

The U.S. stock market has just had its worst January start in history, and other bourses around the world are struggling. Yet by most standards, stocks are undervalued versus inflation and interest rates, and are cheaper than they were in 2002. There are vast amounts of cash on the sidelines, and investor-sentiment measures are very depressed. Meanwhile, the subprime-mortgage disaster continues, and an increasing number of economists are forecasting a recession in the United States this year. Even more frightening, many respected gurus are wringing their hands and warning that the housing and stock-market party bubbles have well and truly burst, and an abyss looms.

The case for the abyss is straightforward: the subprime-mortgage disaster has already seriously weakened U.S. and European financial institutions, and plunging home prices in English-speaking countries are increasing the damage. The bears argue that the U.S. economy is now either in or on the verge of a recession, and the Fed is way behind the curve in reacting to it. Leveraged companies, high-yield (junk) debt and commercial real estate are the next to fall in what will be the most serious financial crisis in the banking system since the end of World War II.

The result, they say, will be a leaderless and extremely dangerous world, fraught with political uncertainty and soaring oil prices. The monstrous liquidity and leveraging binge of the past 20 years is over. Stand by for the hangover: debt liquidation, a round of "creative destruction" and a long period of economic stagnation.

This deadly brew will cause risk premiums on everything to rise, and the prices of equities, commodities and low-quality assets of all kinds to fall steeply. After all, stocks in most countries are either at or close to new highs, so it is not unreasonable to think they could easily decline an additional 20 to 30 percent. This is the prospect that terrifies everyone.

What do I think? I concede that the case for the abyss is possible, but I view it as very unlikely. In my investment lifetime there have been plausible scenarios for the abyss in 1970a74, 1982, 1987, 1997a98, and 2001a02. In each episode, I was scared half to death, the gurus were just as passionately gloomy and there were portfolio-rattling declines. But the world adapted and survived. In fact, the scares were buying opportunities. In the long run, I am always inclined to bet against the abyss, but I recognize that just because it hasn't happened doesn't mean it won't this time.

The so-called authorities have powerful weapons to ...