Merk Market Outlook: Potential Economic Fallout From Credit Crisis

By: Joseph Brusuelas | Fri, Sep 19, 2008
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The events of the past seven days have altered the shape of the market and will impact the economy going forward. The current financial crisis reflects the failure of firms to deleverage in an acceptable period of time. The inability or unwillingness to accept the terms of re-capitalization offered troubled institutions has set in motion the financial train wreck of which we all bear witness. While growth over the past year has exceeded the very low expectations set by the market, the risk to economic output over the remainder of the year is to the downside.

First, the reduction of available credit to consumers and firms will impact overall economic activity. This should be initially observed inside the housing sector. The development community which, until recently took heart in the flattening in the negative slope of housing starts and falling interest rates, will take it on the chin once again as tight credit and lending standards impede the building of homes and the purchase of an already elevated existing stock on the market.

Second there are still pervasive problems in the banking industry. For example, WaMu (not a holding of the Merk Mutual funds) is currently trading just above $2.0 per share down from it recent high of $38.32 in September of 2007 and remains under duress. At the end of Q2'08 WaMu had just north of $150 billion in interest bearing deposits, held $181.5 billion or 58% of its total assets in home lending and wrote off $2.17 billion in non-performing loans, mostly attributed to mortgage defaults, in the second quarter. Currently, the FDIC has $52.413bln in its insurance fund balance and can tap a line of $30bln line of credit at the U.S. Treasury should additional banks fail.

Second, the sharp decline in the value of equities should provide a negative wealth effect on consumers. Personal consumption which we already expect to post a negative print in Q3'08 looks to now possibly contract at a rate of -1.0% during the quarter with additional downside risk in the final quarter of the year.

The decline in the cost of oil and gasoline will provide some savings to consumers and could possibly offset the negative impact on consumer psychology. However, as the recent data suggests even a decline of -4.2% in the cost of gasoline during the month of August did not lead to increase in retail sales during a time when back to school sales traditionally draw consumes into the malls. Given the storm clouds gathering over the consumer we think that recent events should cast a greater shadow over any increase in appetite for consumption.

External demand, which has provided a major source of support for overall economic activity during the now thirteen month financial crisis should see real declines on the back of the global credit tightening that the market is in the process of absorbing. While we are still only days into the recent evolution of the financial crisis, we are observing some unwinding of positions in Emerging Markets and risk aversion plays as capital flows into gold and Swiss Francs, two traditional safe havens in times of crises.

Should credit conditions not return to something approximating normal over the next few days our economic outlook will be adjusted accordingly. At this time, the damage wrought by the latest seizing up in the credit markets has not become an economic event. However, we have inched closer to the outcome and we continue to believe that risk is to the downside for the U.S. economic outlook.



Joseph Brusuelas

Author: Joseph Brusuelas

Joseph Brusuelas
Chief Economist
VP Global Strategy
Merk Investments LLC

Bridging academic rigor and communications, Joe Brusuelas provides the Merk team with significant experience in advanced research and analysis of macro-economic factors, as well as in identifying how economic trends impact investors. As Chief Economist and Global Strategist, he is responsible for heading Merk research and analysis and communicating the Merk Perspective to the markets.

Mr. Brusuelas holds an M.A and a B.A. in Political Science from San Diego State and is a PhD candidate at the University of Southern California, Los Angeles.

Before joining Merk, Mr. Brusuelas was the chief US Economist at IDEAglobal in New York. Before that he spent 8 years in academia as a researcher and lecturer covering themes spanning macro- and microeconomics, money, banking and financial markets. In addition, he has worked at Citibank/Salomon Smith Barney, First Fidelity Bank and Great Western Investment Management.

Mr. Brusuelas lives in Connecticut with his wife and St. Bernard.

Merk Investments LLC is the manager of Merk Mutual Funds, including the Merk Asian Currency Fund and the Merk Hard Currency Fund. The Merk Asian Currency Fund invests in a basket of Asian currencies. Asian currencies the Fund may invest in include, but are not limited to, the currencies of China, Hong Kong, Japan, India, Indonesia, Malaysia, the Philippines, Singapore, South Korea, Taiwan and Thailand.

The Merk Hard Currency Fund invests in a basket of hard currencies. Hard currencies are currencies backed by sound monetary policy; sound monetary policy focuses on price stability.

The Funds may be appropriate for you if you are pursuing a long-term goal with a hard or Asian currency component to your portfolio; are willing to tolerate the risks associated with investments in foreign currencies; or are looking for a way to potentially mitigate downside risk in or profit from a secular bear market. For more information on the Funds and to download a prospectus, please visit

Investors should consider the investment objectives, risks and charges and expenses of the Merk Funds carefully before investing. This and other information is in the prospectus, a copy of which may be obtained by visiting the Funds' website at or calling 866-MERK FUND. Please read the prospectus carefully before you invest.

The Funds primarily invest in foreign currencies and as such, changes in currency exchange rates will affect the value of what the Funds own and the price of the Funds' shares. Investing in foreign instruments bears a greater risk than investing in domestic instruments for reasons such as volatility of currency exchange rates and, in some cases, limited geographic focus, political and economic instability, and relatively illiquid markets. The Funds are subject to interest rate risk which is the risk that debt securities in the Funds' portfolio will decline in value because of increases in market interest rates. The Funds may also invest in derivative securities which can be volatile and involve various types and degrees of risk. As a non-diversified fund, the Merk Hard Currency Fund will be subject to more investment risk and potential for volatility than a diversified fund because its portfolio may, at times, focus on a limited number of issuers. For a more complete discussion of these and other Fund risks please refer to the Funds' prospectuses.

This report was prepared by Merk Investments LLC, and reflects the current opinion of the authors. It is based upon sources and data believed to be accurate and reliable. Opinions and forward-looking statements expressed are subject to change without notice. This information does not constitute investment advise nor a solicitation or an offer to buy or sell any products or services. Foreside Fund Services, LLC, distributor.

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