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2009: Managing The Shift From Deflation Back To Inflation
Japan's Lost DecadeThe 1990’s are known as "the lost decade" in Japan. Fueled by credit expansion, Japan had bubbles in stocks and real estate (sound familiar?). After the bubbles burst, rather than come clean about bad debts, investments, and decisions, the Japanese tried to assist aligning companies with loans. Still saddled with problems many companies were referred to as "zombie firms" since they remained in business, but in a depressed and unhealthy state. Japan did not purge the bad debt and investments from the system.U.S. policymakers have made similar mistakes by helping firms cover-up and hide bad debts and assets with bailouts, loans, and changes in accounting rules. If you are going to print money, provide loans, or intervene in the economy, it is better to do so sooner in the economic downturn rather than later. U.S. policymakers have done that starting with early interest rate cuts in 2007. This is in stark contrast to the almost non-existent initial reaction in Japan and cannot be ignored when making comparisons to the two periods.
Economic Woes Could Lead To Rising TensionsWhile unlikely in 2009, in the coming years we may see a growing global resentment toward policymakers and business leaders who drove the economy and financial system into a ditch. A few more years out, tensions will surely be high as inevitable changes are made to Medicare and Social Security benefits. Higher taxes in a weak economy may add to the typical family’s frustrations of trying to make ends meet.
Doing "The Easy and Self-Serving Thing"Where were the whistleblowers on Wall Street? Who took a stand at the rating agencies and said, “This is wrong – these are not AAA-rated securities”. Where was the conscience of the real estate appraisers, mortgage brokers, and loan officers who in many cases were involved with fraudulent loans in order to line their own pockets? Why didn’t Congress have the political will to deal with the known problems at Fannie and Freddie before they helped bring down our financial system? Why didn’t the Federal Reserve stop its bubble-blowing machine before it was too late? Where was the leadership in the corporate CEO’s office and boardrooms on Wall Street? Why is a recession or company failure unacceptable? Why did policymakers pull out all the stops over the last decade to avoid a recession, which helps clear bad debt and bad decision makers from the system? Why is it acceptable to “walk away” from your mortgage even though you promised to pay? What ever happened to doing the right thing? What happened to working hard, saving your money, and buying things when you can afford them? The concern here is many of the political leaders, CEOs, boards, and market participants who should answer these questions remain employed or in power. We should be concerned about their ability to lead us out of this economic mess.
America Still Is The Best Place To Have An IdeaMoney managers are risk managers, which necessitates being skeptical of all the financial cheerleaders and politicians that keep telling us everything is fine. The United States remains the best place on the planet to have a good idea. Our small investment firm is but one example of the great opportunities available to American citizens. Our freedom has always been and remains our greatest asset. My hope is that during these difficult times our leaders will “do the right thing” even if it means enduring a little political or economic pain.
As Investors, It Is All RelativeWe have outlined numerous concerns about the economic outlook for the United States. Investors, especially currency investors, should keep in mind many of the problems in the United States are also present in other countries, developed and emerging. If you are down on the U.S. dollar, that means you have to be bullish on some other currency. Currency debasement (money printing) is taking place all over the globe. All major currencies are fiat currencies. High debt levels are not confined to the United States. Demographic and entitlement problems are common in other developed nations. Poor leadership and corruption are not unique to our country. In the long run, the best protection against inflation may be with “harder” assets, such as gold, oil, agriculture, etc. rather than taking stakes in other flawed paper currencies.
2003-2007 Bull Market Illustrates Possible ReflationThe recent synchronized global economic boom had never been seen before. Likewise, the synchronized intervention by global governments has never occurred before. Liquidity is being pumped into the global financial system from every corner of the globe. We must be open to and prepared for the possible reflation of asset prices, which includes stocks, bonds, and commodities. If you consider some of the “false gains” created by credit expansion in the 2002-2007 bull market, you become more open to the possibility of the successful reflation of asset prices via the printing press.
Good Blackjack Players Always Reassess The OddsBlackjack is a game of odds. You reduce risk when the odds are against you and take on more risk when the odds are in your favor. Good blackjack players continually reassess their odds as more cards are turned. Good blackjack players are very observant of changing conditions. Money management requires similar skills. As conditions change, the odds of success or failure change. The current environment has a lot of moving parts, which means we must pay close attention to changing fundamentals, technicals, and government policies.
A 2009 Resolution: Stop Investing Based on ForecastsIf you want to have an opportunity to consistently make money in the markets over time, you must be able to keep an open mind about both bullish and bearish outcomes. You must be able to admit one person or organization cannot account for all of the factors that will impact asset prices. If you are becoming defensive reading these comments, ask yourself the following questions:
The sooner you concede no one can consistently forecast outcomes in financial markets, the better off you will be as an investor. You may be 100% correct on the fundamentals, but it is the timing that is nearly impossible to forecast with any consistency. The bearish case for the U.S. dollar was strong in 2008, but there were many other factors at work which drove the dollar higher (factors that many missed). The NASDAQ was overvalued in early 1998, but it also made eye-popping gains from 1998 through March 2000. Why did we exit our weak dollar investments in 2008? Because the market told us to exit. It had nothing to do with anyone’s forecast or view of the economic landscape. If the market tells us to again invest based on dollar weakness and the reflation of asset prices, we will take action.
Many excellent analysts forecasted the bursting of the credit bubble in the late 1990s. Unfortunately, many of them were early with their forecasts and consumed with a singular theme. As a result, they missed the entire 2003-2007 bull market. Many well-known Elliot Wave gurus have been calling for the end of civilization as we know it since 1987. They missed all the gains from 1987-2000 and again from 2003-2007. In today’s environment, many investors are singularly focused on the weak dollar theme. We strongly support the weak dollar theme, but know it is one of many drivers of asset prices. It may turn out to be the central theme, it may not. It can also be detrimental to become focused on a single stock or asset class. "Gold bugs" are known to be continuously bullish on gold. We agree with the case for owning gold, but also know many investors who have suffered great opportunity costs sitting in gold as other asset classes outperformed significantly. We are confident some of the themes we believe in will lead to profits and some of the assets classes we follow will generate positive returns. We are not overly concerned with which themes work and which asset classes make money. We are concerned about having exposure to the winners and avoiding the losers.
Today, a strong case can be made for the S&P 500 to drop all the way to 600 and our approach takes that into account. A reasonable case, especially from a technical perspective, can also be made for the S&P to rally back to 1,150. Even if we drop back to 600, the path could be to move from 930 to 1,150 and then back to 600. Realistically, we have no idea how long such a round trip could take. Stocks and other assets could rally for a year or two and then plummet to new lows. If we stick with an open-minded and disciplined approach which relies on what is happening rather than what we think will happen, we will never stray too far off course. These are not subjective statements based on my opinions. These statements are backed up by research of how to make money in the financial markets. There are numerous books available which describe common and successful approaches to money management. Again, if you want to improve your results, worry much less about what you think may happen and pay attention to what is actually happening. Our objective in the investment markets is to make money. The objective is not to show how smart we are by anticipating and correctly forecasting the direction of any market or asset class. Our fundamental and technical research does help us assess the odds of any particular outcome. Odds involve probabilities; probabilities of being right and probabilities of being wrong. Assessing the odds is important, but paying attention and reacting to observable changes in both the technicals and fundamentals are more important.
To repeat from the opening paragraph, our focus is on mastering proven and repeatable methods which can improve our odds of investment success. If you do your own research on proven investment methods that are effective in bull and bear markets, you will find little or no emphasis placed on forecasting. In 2009, try to stop using phrases such as “I think”, “he thinks”, “they forecast”, or “I just can’t see that happening”. See if you can replace them with “we’ll see how things play out”, “the odds favor”, “there are a lot of moving parts, we could be wrong”, and “we are prepared for and open to numerous outcomes.” The best way to “forecast” is to observe current trends and expect them to continue until you observe evidence to the contrary. Currently, the observable trends remain negative. We have seen enough positive observable evidence to get our attention, but we still need to respect the prevailing downtrend while keeping an open mind about a possible change of trend. If capital needs to be deployed in the coming days or months, we stand ready to take action.
Final Thoughts As We Head Into 2009
CCM Technical Rank 2009
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