| If you're not confused by this stock market, you're | | | | major metropolitan markets. Bank lending continues |
| probably not paying attention. The Dow-Jones Index | | | | to be minimal relative to the huge amount of liquidity |
| halved from an all time high of more than 14,000 in | | | | created by an expansive monetary policy, and |
| October 2007 to less than 6,600 in March 2009. From | | | | money velocity remains very slow; and Many |
| March until September 2009, the index increased | | | | knowledgeable investors are leery of investing in the |
| 50% to 9,800. Many pundits now believe that a new | | | | stock market, even with this summer's robust rally. |
| bull market is emerging and just as many believe a | | | | Corporate insiders are selling shares more than usual |
| correction is coming; some believe the pullback may | | | | and cash on the sidelines, at 30% of total equity |
| retrace the March lows. | | | | value, is still well above the typical 20% average cash |
| The optimists believe that the speculative bubble is | | | | ratio. What do they know that we don't? |
| now deflated, reflation is well under way and that a | | | | Governments around the world seem to be |
| modest correction may be coming merely because | | | | cooperating to fight deflation, but what if all that |
| the market rallied too far too fast. They see investor | | | | reflation is not enough to plug the multi-trillion dollar |
| sentiment as too bullish and point to retail investors | | | | hole left by disappearing debt? Additional stimulus is |
| pouring money back in the market as an indicator of | | | | always a possibility, but lowering interest rates |
| a temporarily overheated market. (In March, cash | | | | already near zero won't add much stimulus. Japan |
| amounting to 46% of the total value of our equity | | | | learned those lessons the hard way in the early |
| markets was parked in money market accounts, but | | | | 1990s and is still in the economic doldrums today! |
| by September that ratio fell to 30%.) | | | | Moreover, and assuming we successfully dodge a |
| Pessimists, however, believe that the current market | | | | deflationary spiral, a long period of significant |
| recovery is temporary and point to significant | | | | world-wide inflation is likely to result from all that |
| economic problems yet to be addressed. They | | | | monetary and fiscal stimulation being employed right |
| believe that the looming risk of deflation will cause | | | | now. That will be bad news for economic growth, |
| the coming correction to be protracted and severe; | | | | but global governments will actually benefit as high |
| they also believe continued problems in the financial | | | | inflation over a long period of time will reduce the real |
| sector could catalyze another major deflationary | | | | cost of all that government debt and make it |
| spiral. | | | | cheaper to repay. Governments know this and often |
| The consensus among optimists and pessimists is | | | | inflate out of their debt. That fact alone almost |
| that unprecedented global government spending and | | | | guarantees that inflation is in our future. Some believe |
| deficits will eventually lead to robust (if not hyper) | | | | gold's recent steady price rise is already signaling the |
| inflation. The pessimists, however, also believe that all | | | | inevitability of future high inflation. |
| those "reflation efforts" will prove insufficient to keep | | | | Obviously, no one really knows if any of this will play |
| the world economy from returning to the brink of | | | | out in reality. But if you subscribe to the deflation |
| collapse. | | | | theory, you should probably sell into the current |
| They argue that all the spending and expansive | | | | stock market rally, patiently collect cash and wait for |
| monetary measures should continue until deflation is | | | | the opportunity to reinvest when the market tanks. |
| realistically off the table. The Great Depression was | | | | Also, if deflation is indeed coming, now probably isn't |
| the last major deflation, so even today's experts are | | | | the best time to borrow money or buy a house. |
| unfamiliar with the phenomenon and, as a result, are | | | | Deflation will make borrowing more expensive in real |
| much more frightened by it than the more common | | | | terms and will obviously impair the real value of your |
| inflation. Ample anecdotal evidence suggests that the | | | | home. If deflation does occur it is likely to be |
| risk of deflation should be seriously considered: | | | | triggered by some economic or geo-political panic |
| The goal of delevering the global economy to a | | | | event and likely to persist for several months if not |
| debt-to-global-GDP ratio half its peak of 400% will | | | | years. |
| require, for example, a 30% global debt reduction | | | | If you don't subscribe to the deflation theory, but |
| and a 30% increase in global GDP. That process will | | | | believe high inflation is coming, you should consider |
| be difficult and will take liquidity out of the global | | | | repositioning your portfolio and invest selectively, |
| economy. Current global government spending in the | | | | especially in proven inflation hedges such as gold, oil, |
| trillions may still not be enough stabilize the | | | | commodities, real estate, and other tangible assets. |
| deflationary vacuum caused by eliminating all that | | | | Furthermore, if you believe the US dollar will weaken |
| debt. | | | | relative to other currencies because of inflation and |
| Consumer prices continue to fall as | | | | other factors, investing abroad or in US companies |
| debt-overextended consumers curtail their | | | | that export or otherwise earn significant income |
| discretionary purchases in an effort to firm up their | | | | abroad probably makes sense too. |
| personal balance sheets. Private consumption | | | | Many knowledgeable investors expect some type of |
| representing 70% of the US economy is unlikely to | | | | correction (minor or major) within the next several |
| bail us out of our economic doldrums as it has in the | | | | months, early-to-mid 2010. In addition, some expect |
| past. | | | | the Fed to start tightening as early as late 2010, |
| The US recession may be finished, but no one | | | | which suggests that deflation risk should be |
| expects a robust recovery. Continued rising | | | | significantly reduced by then and replaced by inflation |
| unemployment and slow growth will exacerbate tepid | | | | as the dominant price stability concern for policy |
| consumer demand and the delevering process. | | | | makers. A significant increase in bank lending will be |
| Banks are still failing at an alarming rate and many | | | | another sign that inflationary pressure is building. |
| believe a looming crisis in commercial real estate, | | | | Are you optimistic or pessimistic? Are you more |
| consumer credit and all types of derivative products | | | | comfortable missing a market rally by selling your |
| are the proverbial shoes waiting to drop that could | | | | investments in anticipation of deflation, or ignoring the |
| stress an already fragile global financial system. | | | | signs of deflation, riding the current rally and risking |
| Additionally, financial reform designed to prevent the | | | | your gains on a potential big correction? A realistic |
| problems that caused this crisis is still lacking and, in | | | | assessment should probably weight each possible |
| fact, irresponsible mortgage lending practices | | | | outcome as equally likely. |
| continue, ostensibly to bolster otherwise lackluster | | | | Consequently, now is probably not the right time to |
| residential real estate sales. | | | | go all in or stay completely out of the market. |
| Residential real estate prices continue to fall in many | | | | |