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Ready for a 300-point Drop in the S&P 500?

A Royal Bank of Scotland credit strategist, Bob Janjuah, rattled investors around the world today with predictions that the S&P 500, now trading near 1340, could plunge to 1050 by September, as “‘all the chickens come home to roost’ from the global boom.”

“A very nasty period is soon to be upon us — be prepared,” he said, according to the Daily Telegraph.

Bits and pieces of Janjuah’s warning to RBS clients seem to be floating around the Internet. However, RBS spokespeople said the note was for RBS clients only. They said they couldn’t provide me and other members of the media with a full copy of the report. An RBS representative implied Janjuah was definitely speaking for himself and not for the bank as a whole.

Based on what I have seen, Janjuah’s argument is that the European and U.S. economies will show a lot of weakness this summer. That will put the U.S. Federal Reserve and possibly the European Central Bank in a bind: If they raise interest rates, they would slow an already weak economy right before a U.S. presidential election. If they don’t hike rates, they would allow inflation to increase uncontrollably. Unchecked inflation would seriously disturb the world’s investors.

Janjuah reportedly wrote:

The Fed is in panic mode. The massive credibility chasms down which the Fed and maybe even the ECB will plummet when they fail to hike rates in the face of higher inflation will combine to give us a big sell-off in risky assets.

If that sounds a little overblown and hyperbolic to you (“panic mode,” really?), I agree. But it seems fitting for a guy who is predicting one of the biggest stock meltdowns of all time.

Should investors take this seriously? The dilemma for central bankers that he describes is real. Janjuah reportedly predicted the credit crunch in 2007, which gives him some credibility. But some are skeptical of him, namely the mysterious StockJockey at 1440 Wall Street: “While Americans have an addiction to oil, Bob Janjuah is addicted to making high profile market predictions that draw attention,” he wrote.

In the interests of a good night’s sleep, here are a few reasons Janjuah’s nightmare might not come true:

1. The price of oil could drop or even stabilize, easing inflationary pressures.

2. While oil and other commodity prices could continue rising in price, labor costs (which make up a huge portion of corporate expenses) could remain stagnant. Rising prices and stagnant wages will be no fun for American or European consumers, but that could keep inflation in check.

3. The European and U.S. economy could be growing fast enough to allow the Federal Reserve to safely raise rates later this year. Or the Fed would risk a mild recession to get a handle on inflation.

Anyway, Janjuah’s worries can’t be dismissed out of hand. But unless he’s a psychic, there are a lot of other ways the future could unfold.

UPDATE: I notice BW colleague Lauren Young simultaneously blogged on Janjuah’s warnings from a different angle below. Check it out…

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