I am not bullish but I am not bearish either
Happy Friday. Here’s a quick gold-level note note on what I think is going on in the markets and the economy right now that I am making freely available.
Turning to the paradigm I set out in 2009, the following points frame the secular environment:
- The household sector in many countries is overly indebted. The natural tendency, therefore, is toward more saving and less spending in the household sector (although asset price appreciation can attenuate this through the Wealth Effect). From a national accounting perspective, this necessarily means the public sector or the nonfinancial business sector must run deficits or the import-export sector must run a surplus.
- Most countries are still in a state of economic weakness. Even emerging markets like China, India and Brazil are seeing weakening growth. That means consumption demand is constrained globally. Conclusion: There is zero chance the US or the euro zone periphery can export their way to sustained recovery without a collapse in the value of their currencies.
- State and local governments are still constrained as currency users by the inability to print money and weak tax receipt growth. So from a national accounting perspective, only the Federal Government can run large deficits absent a business sector capital investing binge.
- Because consumption growth is still uneven, I see the capital investment binge as unlikely and that means increased private savings must be facilitated by government deficits.
- Politically, expansionary fiscal policy has come under and will continue to come under assault, particularly in the euro zone where national governments are currency users and vulnerable to bond vigilantism.
- So all major central banks will inflate the currency base as much as they can reasonably get away with. This policy creates currency weakness and a competitive currency devaluation dynamic which has led to the so-called currency wars and the likelihood of sustained capital controls, currency intervention and nationalist economic responses. But these policies will work in creating asset price inflation and temporarily boosting economic growth.
- I believe this dynamic will induce a Scylla and Charybdis of inflationary and deflationary forces, forcing central bankers to add and withdraw liquidity in a manic way. Financial repression will cause a secular decline in real yields across developed and developing economies. For investors like pension funds with nominal return targets and future payout liabilities, risk seeking return plays have proliferated to create huge shifts in private portfolio preferences. In particular, portfolio preference shifts into commodity assets due to easy money will increase the volatility of inflation and act as a tax on developing economies and the less well-off in developed economies.
- The likely volatility in government spending and taxation gives you the makings of a depression shaped like a series of W’s consisting of short and uneven business cycles. Consumers will not deleverage in earnest during cyclical upswings but will overcompensate during recession. The secular force, therefore, is the D-process and the deleveraging, so I expect deflation to be the resulting secular trend more than inflation.
- As we are now realising, this kind of volatility induces a wave of populist sentiment, leading to an unpredictable and violent geopolitical climate and the likelihood of more muscular forms of government.
I will say this: we are in a cyclical bull market right now. Lower jobless claims and higher credit growth despite slow income gains tell me that the cycle is well advanced. Because of household indebtedness, the commodity volatility tax, and fiscal consolidation I expect this cycle to be cut short. The US has resisted the fiscal consolidation, and has, therefore, benefitted from higher growth than Europe. But how much longer will it do so? My initial prediction in 2009 was that the upcycle would last 4 years at most i.e. to 2013. I stick by that. I expect economic weakness to begin in the second half of this year. This will turn into recession unless we see a countervailing effort by business or government. Watch China, India, Brazil and the US in particular because those countries are now leading global growth. For canaries in the coalmine, watch Australian house prices because Australia is commodity-dependent and the overvalued housing sector is coming off the boil. Any slowdown that feeds through into commodity price weakness will exacerbate weakness there and be a harbinger of larger problems.
From an investing standpoint, consider this a secular bear market for stocks then. Play the rallies, but be cognizant that the secular trend for the time being is still down.