Storm warning: Equity markets are in for a rough ride

If the recent slide in global equity markets has unnerved you, you probably need a strong dose of a tranquilliser to face what lies ahead.

Analysts are warning of rough weather ahead, the effect of which could lead to a “global deflationary bust” and spiralling trade tensions (and perhaps even geopolitical friction). All of this will lower investors’ capacity to embrace risk assets, and in such a scenario, they reason, equity markets could get pummelled, with US equities falling by - hold your breath - nearly 70%.

“We expect a global deflationary bust to reverse the clear inflationary pressures building from monetary debauchment around the world,” cautions Societe Generale’s global strategist Albert Edwards, who has a well-reputation for saying it like it is.

“If, as last year, we see a severe economic slowdown… this could rekindle geopolitical tensions,” he adds. The trigger for that, in his estimation, would be heightened trade tension, particularly between the US and China, given that the US is currently experiencing a “record seasonally adjusted trade deficit with China”.

That record deficit is being camouflaged momentarily by some “favourable seasonal effects”, but the cover will be blown off from June onwards, when the true extent of the deficits are revealed, particularly if US economic growth sputters as the second round of Quantitative Easing draws to a close.

Signs of a global economic slowdown are already manifesting themselves.

China’s Purchasing Manufacturers Index, a measure of the heartbeat of its manufacturing economy, recently came in weaker than anticipated. This has led legendary investor Marc Faber to call a “technical recession” in China next year. He told Bloomberg TV : “Within one year, the Chinese economy will perform poorly… it will have a recession.”

That jaw-dropping claim had the intended effect on the Bloomberg anchor. “A recession in China?” she asks incredulously.

To which Faber responds: “it could be a technical recession; if you slow down from a growth rate of 10% to a growth rate of 3%, that is a recession.”

In any case, Faber says, “I don’t believe in the growth figures that China publishes… If you had adjusted nominal GDP for the true rate of inflation, real growth is much slower.”

Faber’s call on the Chinese economy is wildly at variance with a ranking by Bloomberg of the sustainability of economic momentum in developing Asia. That listing has China first among 22 emerging Asian economies “as the country most likely to main steady and rapid growth over the next five years.” (India was second in the ranking.) Bloomberg reported that the index suggested that “China and India’s economic surge is durable and will likely continue to drive global growth as the US, Europe and Japan lag behind.”

Yet, in the short term, the outlook on the global economy is distinctly downbeat, which is compounded by the sovereign debt crisis in the Eurozone countries.

Edwards argues that the risk aversion that this gloom-and-doom scenario induces will roil equity markets. He sees US equity markets as being particularly vulnerable: the S&P could, in his reckoning, go down to 400 from the current level of 1,250 or so, which is a fall of nearly 70%. In that assessment, he is joined by Russell Napier, a masterly financial historian, who lays out an eloquent case to explain why that would happen.(Catch an earlier interview with Napier, in which he outlines his view of the global economy here .)

Faber too says he’s “ultra careful” for now with his investments because he sees a boom everywhere. “For my taste, there are far too many Ferraris, Maseratis and Bentleys in front of luxury hotels (in the US), and that’s not a good sign.”

The wealth he sees floating around the prices people are paying for high-end properties is “incredible” and “will come to an end.” In the process, he adds, “a lot of people” will lose “a lot of money”.