If you’re not confused by this stock market, you’re probably not paying attention. The Dow-Jones Index halved from an all time high of more than 14,000 in October 2007 to less than 6,600 in March 2009. From March until September 2009, the index increased 50% to 9,800. Many pundits now believe that a new bull market is emerging and just as many believe a correction is coming; some believe the pullback may retrace the March lows.
The optimists believe that the speculative bubble is now deflated, reflation is well under way and that a modest correction may be coming merely because the market rallied too far too fast. They see investor sentiment as too bullish and point to retail investors pouring money back in the market as an indicator of a temporarily overheated market. (In March, cash amounting to 46% of the total value of our equity markets was parked in money market accounts, but by September that ratio fell to 30%.)
Pessimists, however, believe that the current market recovery is temporary and point to significant economic problems yet to be addressed. They believe that the looming risk of deflation will cause the coming correction to be protracted and severe; they also believe continued problems in the financial sector could catalyze another major deflationary spiral.
The consensus among optimists and pessimists is that unprecedented global government spending and deficits will eventually lead to robust (if not hyper) inflation. The pessimists, however, also believe that all those “reflation efforts” will prove insufficient to keep the world economy from returning to the brink of collapse. They argue that all the spending and expansive monetary measures should continue until deflation is realistically off the table. The Great Depression was the last major deflation, so even today’s experts are unfamiliar with the phenomenon and, as a result, are much more frightened by it than the more common inflation. Ample anecdotal evidence suggests that the risk of deflation should be seriously considered:
The goal of delevering the global economy to a debt-to-global-GDP ratio half its peak of 400% will require, for example, a 30% global debt reduction and a 30% increase in global GDP. That process will be difficult and will take liquidity out of the global economy. Current global government spending in the trillions may still not be enough stabilize the deflationary vacuum caused by eliminating all that debt;
Consumer prices continue to fall as debt-overextended consumers curtail their discretionary purchases in an effort to firm up their personal balance sheets. Private consumption representing 70% of the US economy is unlikely to bail us out of our economic doldrums as it has in the past;
The US recession may be finished, but no one expects a robust recovery. Continued rising unemployment and slow growth will exacerbate tepid consumer demand and the delevering process;
Banks are still failing at an alarming rate and many believe a looming crisis in commercial real estate, consumer credit and all types of derivative products are the proverbial shoes waiting to drop that could stress an already fragile global financial system. Additionally, financial reform designed to prevent the problems that caused this crisis is still lacking and, in fact, irresponsible mortgage lending practices continue, ostensibly to bolster otherwise lackluster residential real estate sales;
Residential real estate prices continue to fall in many major metropolitan markets;
Bank lending continues to be minimal relative to the huge amount of liquidity created by an expansive monetary policy, and money velocity remains very slow; and
Many knowledgeable investors are leery of investing in the stock market, even with this summer’s robust rally. Corporate insiders are selling shares more than usual and cash on the sidelines, at 30% of total equity value, is still well above the typical 20% average cash ratio. What do they know that we don’t?
Governments around the world seem to be cooperating to fight deflation, but what if all that reflation is not enough to plug the multi-trillion dollar hole left by disappearing debt? Additional stimulus is always a possibility, but lowering interest rates already near zero won’t add much stimulus. Japan learned those lessons the hard way in the early 1990s and is still in the economic doldrums today!
Moreover, and assuming we successfully dodge a deflationary spiral, a long period of significant world-wide inflation is likely to result from all that monetary and fiscal stimulation being employed right now. That will be bad news for economic growth, but global governments will actually benefit as high inflation over a long period of time will reduce the real cost of all that government debt and make it cheaper to repay. Governments know this and often inflate out of their debt. That fact alone almost guarantees that inflation is in our future. Some believe gold’s recent steady price rise is already signaling the inevitability of future high inflation.
Obviously, no one really knows if any of this will play out in reality. But if you subscribe to the deflation theory, you should probably sell into the current stock market rally, patiently collect cash and wait for the opportunity to reinvest when the market tanks. Also, if deflation is indeed coming, now probably isn’t the best time to borrow money or buy a house. Deflation will make borrowing more expensive in real terms and will obviously impair the real value of your home. If deflation does occur it is likely to be triggered by some economic or geo-political panic event and likely to persist for several months if not years.
If you don’t subscribe to the deflation theory, but believe high inflation is coming, you should consider repositioning your portfolio and invest selectively, especially in proven inflation hedges such as gold, oil, commodities, real estate, and other tangible assets. Furthermore, if you believe the US dollar will weaken relative to other currencies because of inflation and other factors, investing abroad or in US companies that export or otherwise earn significant income abroad probably makes sense too.
Many knowledgeable investors expect some type of correction (minor or major) within the next several months, early-to-mid 2010. In addition, some expect the Fed to start tightening as early as late 2010, which suggests that deflation risk should be significantly reduced by then and replaced by inflation as the dominant price stability concern for policy makers. A significant increase in bank lending will be another sign that inflationary pressure is building.
Are you optimistic or pessimistic? Are you more comfortable missing a market rally by selling your investments in anticipation of deflation, or ignoring the signs of deflation, riding the current rally and risking your gains on a potential big correction? A realistic assessment should probably weight each possible outcome as equally likely. Consequently, now is probably not the right time to go all in or stay completely out of the market.
Monday, September 21, 2009
Tuesday, September 15, 2009
Foreign Critics of US Government Spending Should Rethink Their Opinions
Foreign critics envious of America’s robust consumption and spending are taking some pleasure in seeing America struggle through its current financial crisis. However, as they celebrate our misfortune they should realize that they too have benefited from our excesses and if the golden goose dies, they too will do without its seemingly endless generosity.
By all historical measures, America is straining its purse strings. Current budget deficit and government spending estimates as a percentage of GDP are 12% and 28% respectively, and are unacceptably high levels not seen since World War II. US debt as a percentage of GDP is currently 45% and is projected to nearly double in the next ten years.
America is particularly fortunate that its sovereign friends around the world are willing and able to lend us the money we need to sustain our nation. But those lenders are being more than fairly compensated for their support. China, Japan and other nations lend us money by buying our interest-paying bonds, the most risk-free investment available, all to give us the wherewithal to buy their exports and pay for, among other things, the one trillion dollars the US spends annually to maintain the peace and security of the planet we all share. That security provides the backdrop of certainty and confidence that all the world’s nations need to grow their economies, trade freely and ultimately improve their quality of life. As such it should be obvious that our lenders have as much at stake as we do. Don’t you wish you could lend money to our government virtually risk free, instead of paying income taxes, for the services you receive?
Additionally, the US spends by far more than any other nation on global humanitarian endeavors. Even our enemies that engage us in warfare are compensated in defeat. After World War II, America practically rebuilt Europe and Japan. Plans for how America will rebuild Iraq began almost simultaneously with the war itself several years ago. Currently there are serious discussions about building infrastructure in Afghanistan as part of a strategy to achieve a victory there. Don’t you wish your conquering enemies were as kind to you?
Everyone should be rooting for America to get its fiscal house in order for our sake, and for the sake of our friends and our enemies.
By all historical measures, America is straining its purse strings. Current budget deficit and government spending estimates as a percentage of GDP are 12% and 28% respectively, and are unacceptably high levels not seen since World War II. US debt as a percentage of GDP is currently 45% and is projected to nearly double in the next ten years.
America is particularly fortunate that its sovereign friends around the world are willing and able to lend us the money we need to sustain our nation. But those lenders are being more than fairly compensated for their support. China, Japan and other nations lend us money by buying our interest-paying bonds, the most risk-free investment available, all to give us the wherewithal to buy their exports and pay for, among other things, the one trillion dollars the US spends annually to maintain the peace and security of the planet we all share. That security provides the backdrop of certainty and confidence that all the world’s nations need to grow their economies, trade freely and ultimately improve their quality of life. As such it should be obvious that our lenders have as much at stake as we do. Don’t you wish you could lend money to our government virtually risk free, instead of paying income taxes, for the services you receive?
Additionally, the US spends by far more than any other nation on global humanitarian endeavors. Even our enemies that engage us in warfare are compensated in defeat. After World War II, America practically rebuilt Europe and Japan. Plans for how America will rebuild Iraq began almost simultaneously with the war itself several years ago. Currently there are serious discussions about building infrastructure in Afghanistan as part of a strategy to achieve a victory there. Don’t you wish your conquering enemies were as kind to you?
Everyone should be rooting for America to get its fiscal house in order for our sake, and for the sake of our friends and our enemies.
Friday, September 11, 2009
Reforming Obamacare
The president addressed a rare joint session of Congress Wednesday night and rather eloquently laid out his "wish list" for healthcare reform (“Obamacare”), this time with specific talking points about who and how Americans will benefit. As far as program details or how it will be financed, the president either isn't saying or doesn't yet know.
The president's lack of transparency and detail coupled with the government's long history of profligate entitlement spending makes it easy to understand why Americans are reluctant to buy into the president’s program, especially when the reform narrative keeps changing. The original priority was to insure the 47 million uninsured, but quickly turned to overhauling our entire healthcare system, one that according to polls satisfactorily serves 75 percent of the 250 million insured. Called out by protesters at the prospect that taxpayer money would subsidize healthcare for illegals, the president changed his tune and referred to 30+ million uninsured and assured us that illegal aliens will not be insured under his program.
Originally, healthcare reform was going to be substantially paid for with cuts in Medicare and new taxes on the wealthy. Seeing backlash from seniors probably led the president to rethink that approach and definitively say that there will be no Medicare cuts to pay for Obamacare. The president is now saying that half the costs of Obamacare can be paid for by eliminating the waste, fraud and inefficiency from the existing system. That's a difficult one to swallow especially knowing that one of the House proposals calls for 53 new government bureaucracies to be created under Obamacare!
President Obama is urging us to “trust him,” but has not earned that trust. Critics of Obamacare point to language in the various proposals that refute many of the assertions made by the president in his speech. The president hasn't backed up any of his statements with any details or actual documentation. In addition, he "sold" us Obamacare by hyping the positives, without acknowledging even the possibility that there will be unintended and potentially negative repercussions from such comprehensive and complicated changes to our system. Finally, his stimulus plan early this year showed us that he has neither the experience, expertise nor the inclination to add value to his own programs.
Notwithstanding all the evidence to the contrary, the president says that he is seeking incremental reform that fixes the problems with our system. If he truly means what he says, his “incremental” reform should consider the following common sense suggestions:
Enable interstate competition among insurance companies. Greater competition among insurance providers should lead to cheaper insurance for consumers. We buy our home, auto and life insurance in a national marketplace, why shouldn’t we buy our health insurance there too? Instead, Obamacare proposes to create some type of national exchange for insurance companies. Apparently, no one knows how it will work, including the president.
Eliminate mandates for minimum insurance coverage. One reason health insurance is so expensive is that we’re forced to buy insurance for every conceivable health condition and situation. Again, Americans select their home, auto and life insurance by making choices among coverage alternatives, why should health insurance be any different? Let consumers select from a menu according to their own needs, once their basic needs are met. Healthy young people, for example, who otherwise would not seek any insurance, should be encouraged to purchase “catastrophe insurance” to insure against major events that can potentially strike at any time.
Reform medical malpractice law (tort reform). The president mentioned tort reform last night, but his comments clearly indicate that he has no intention of taking decisive action in the time frame contemplated for his reform package. Many believe tort reform is critically needed in order to contain future healthcare costs. If the president is serious about reforming healthcare, he needs to put aside the long-standing allegiance of the democrats to the civil trial lawyers of America.
Tort reform refers to making changes to our civil justice system that would limit the incidence and monetary awards arising from litigation. Should victims of medical malpractice be compensated for their misfortune? Absolutely, but does the average settlement need to exceed a million dollars, and should that practice be allowed to paralyze and potentially bankrupt our healthcare system? Approximately one third of our healthcare costs are driven by “defensive” medicine and more than 80 percent of U.S. doctors admit they require unnecessary tests for their patients just to avoid potential patient lawsuits arising from alleged negligence on their part. Tort reform has the potential to save $100 billion annually in healthcare costs and any proposed reform of healthcare should address the cost, waste and inefficiency created by the current law.
Provide tax incentives to individuals who purchase health insurance. Employers and businesses pay for employee insurance premiums with after tax dollars, why shouldn’t all of us be able to do the same?
These ideas have the advantage of being straightforward and can be implemented incrementally. I hope the president will keep his promise and seriously consider them for his healthcare reform program.
The president's lack of transparency and detail coupled with the government's long history of profligate entitlement spending makes it easy to understand why Americans are reluctant to buy into the president’s program, especially when the reform narrative keeps changing. The original priority was to insure the 47 million uninsured, but quickly turned to overhauling our entire healthcare system, one that according to polls satisfactorily serves 75 percent of the 250 million insured. Called out by protesters at the prospect that taxpayer money would subsidize healthcare for illegals, the president changed his tune and referred to 30+ million uninsured and assured us that illegal aliens will not be insured under his program.
Originally, healthcare reform was going to be substantially paid for with cuts in Medicare and new taxes on the wealthy. Seeing backlash from seniors probably led the president to rethink that approach and definitively say that there will be no Medicare cuts to pay for Obamacare. The president is now saying that half the costs of Obamacare can be paid for by eliminating the waste, fraud and inefficiency from the existing system. That's a difficult one to swallow especially knowing that one of the House proposals calls for 53 new government bureaucracies to be created under Obamacare!
President Obama is urging us to “trust him,” but has not earned that trust. Critics of Obamacare point to language in the various proposals that refute many of the assertions made by the president in his speech. The president hasn't backed up any of his statements with any details or actual documentation. In addition, he "sold" us Obamacare by hyping the positives, without acknowledging even the possibility that there will be unintended and potentially negative repercussions from such comprehensive and complicated changes to our system. Finally, his stimulus plan early this year showed us that he has neither the experience, expertise nor the inclination to add value to his own programs.
Notwithstanding all the evidence to the contrary, the president says that he is seeking incremental reform that fixes the problems with our system. If he truly means what he says, his “incremental” reform should consider the following common sense suggestions:
Enable interstate competition among insurance companies. Greater competition among insurance providers should lead to cheaper insurance for consumers. We buy our home, auto and life insurance in a national marketplace, why shouldn’t we buy our health insurance there too? Instead, Obamacare proposes to create some type of national exchange for insurance companies. Apparently, no one knows how it will work, including the president.
Eliminate mandates for minimum insurance coverage. One reason health insurance is so expensive is that we’re forced to buy insurance for every conceivable health condition and situation. Again, Americans select their home, auto and life insurance by making choices among coverage alternatives, why should health insurance be any different? Let consumers select from a menu according to their own needs, once their basic needs are met. Healthy young people, for example, who otherwise would not seek any insurance, should be encouraged to purchase “catastrophe insurance” to insure against major events that can potentially strike at any time.
Reform medical malpractice law (tort reform). The president mentioned tort reform last night, but his comments clearly indicate that he has no intention of taking decisive action in the time frame contemplated for his reform package. Many believe tort reform is critically needed in order to contain future healthcare costs. If the president is serious about reforming healthcare, he needs to put aside the long-standing allegiance of the democrats to the civil trial lawyers of America.
Tort reform refers to making changes to our civil justice system that would limit the incidence and monetary awards arising from litigation. Should victims of medical malpractice be compensated for their misfortune? Absolutely, but does the average settlement need to exceed a million dollars, and should that practice be allowed to paralyze and potentially bankrupt our healthcare system? Approximately one third of our healthcare costs are driven by “defensive” medicine and more than 80 percent of U.S. doctors admit they require unnecessary tests for their patients just to avoid potential patient lawsuits arising from alleged negligence on their part. Tort reform has the potential to save $100 billion annually in healthcare costs and any proposed reform of healthcare should address the cost, waste and inefficiency created by the current law.
Provide tax incentives to individuals who purchase health insurance. Employers and businesses pay for employee insurance premiums with after tax dollars, why shouldn’t all of us be able to do the same?
These ideas have the advantage of being straightforward and can be implemented incrementally. I hope the president will keep his promise and seriously consider them for his healthcare reform program.
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