Friday, September 25, 2009

Deflation Straight Ahead?

Hi All

Sorry it's been so quiet around here. Keep checking in because I will post when I get a chance.

Let's get to the markets:

Hmmmm.....Is that the smell of Deflation in the air? The market sure seems to be acting like it.

Let me preface my deflation take by stating that the market is totally manic right now. I expect both inflationary and deflationary panics as the US economy stands on the brink of collapse.

Earlier this year, the Fed turned on the printing press as the economy collapsed hoping that companies and consumers would feel more confident and start spending as things appeared to get back to normal.

As much as we hate it, the Fed must replace the consumer during tough economic times until both the consumer and corporations heal their balance sheets. This usually works very effectively during a mild recession: 1987, 1990, 2001 anyone?

As companies and the consumer recover, the Fed can then yank their liquidity once the economy stabilizes and the private sector is stable enough to stand on it's own.

The problem we have this go around is the economy collapsed in 2008. The Fed has tried to react like it always has and attempted to replace the private sector. What we are slowly learning is that the balance sheets of the consumer this go around are practically beyond repair.

How does an average Joe ever pay off a $600,000 30 year home loan? Answer: He doesn't.

As a result, the Fed is in a real jam with few options. They can't replace the consumer forever because the deficits would eventually destroy the dollar. However, if they pullout, the economythen collapses because the private sector is too damaged to replace them. This would assuredly lead to a deflationary death spiral like we saw in Japan in the '90's and here in the US in the 1930's.

The Bottom Line:

So what will the Fed do? That's the million dollar question. Do they spend spend spend until they create a currency/hyperinflation nightmare?


Do they fold their hand and let the economy collapse via deflation?

The market appears dazed and confused on this issue. Before this week, the market was screaming inflation as the metals, stocks, and other commodities went on a tear.

This week things changed after the Fed statement. The market began to sell off and both bonds and the dollar started to to rally. What was most noticeable was there was a lot of buying in the long end of the bond market(10/30 year).

This price action screams deflation. The reason I say this is why would anyone buy a 30 year bond at a 4% yield if they expect inflation to rise 10% a year? Answer: They wouldn't because they would be 6% in the hole each year.

So is it deflation or inflation? We have seen panics in both directions in the past few weeks. I don't expect this to change much in the near future.

The future of the dollar and the world economy is very much in the air. This is a time where investors must focus on capital preservation versus yield.

IMO, diversification is a must for both inflation and deflation.

Batten down the hatches folks, there is a nasty storm on the horizon.


Anonymous said...

Seems to me the Fed wants a deflationary environment for temporary. Since the last crash in March, many people have pulled money out of the stock market and moved them into CD/saving accounts. But as interest rates drop to 1% and less, what is the point to keep the money safe anymore. You are earning peanuts. So might as well move the money back into the stock market and take another chance. With more retail investors getting back, stock prices increase due to more buyers. This creates an illusion of a recovered market. And this is what the Fed wants. They want people to believe that the market is recovering in order to keep the game going.

Once there are enough money in the market, the Fed will start the pull liquidity in order to prop up the dollar.

Jeff said...


Yup thats pretty much what the Fed has done.

The problem is at some point you need to have earnings to come at levels that justify the stock prices.

As earnings continue to decline of stay flat, the fundementals start to matter and they will roll back over.

I do think in Q3/Q4 many companies will have a chance to beat earnings from last year because the economy essentially stopped this time last year.

As a result, they may be able to continue to reshuffle the chairs on the deck of this Titanic through the rest of the year.

Jumping into equities after a 50% move is a risky proposition.

I think we may see a slight pullback of maybe 10% or so. The bulls will then buy on the pullback thinking they gotta bargain.

this is where things get really dicey because I think companies will massively disssapoint Wall Streest's earnings expection starting in Q1 2010.

This is when its going to get really ugly IMO.

I don't think the dollar will ever recover from this in the long run unless we see a deflationary collapse.

Scary times.

getyourselfconnected said...

Deflation seems to be the consensus right now. I noticed the FED making some inklimgs about policy retraction, but I think the events of the next two months (higher unemployment, collapsed auto sales, serious drop in home sales, and the FDIC running empty) is going to force them into action once again. They will probably fail in their quest, but I think the dollar will be sacrificed as a last ditch effort.

Who knows, but I will be watching as it unfolds.
Take care.

Jeff said...


I agree bud.

Will the Fed act? That's the million dollar question.

Once side of the trade(inflationists or deflationists) is going to get smashed when we get our answer.

I tend to agree with you.
Our arrogance and lack of pain threshold will trigger more spending of dollars we don't have.

Hopefully we get our answer soon. This recession is really taking it's toll everyone.

I am kinda hoping for an economic/deflation reset back to adffordability.

Its will be painful but essential for a sustained recovery.

CT-Hilltopper said...

I think the person who posted anonymously has a lot of wisdom in their post.

People in government count on the populace having short attention spans. If they can get the media to keep talking the green shoots crap for long enough, then eventually people will start to believe it, and will start to put their money back in the market.

The unfortunate fact is that the government is right about a majority of the American public.

I believe that the market has just about topped, and is ready to come back down. I'm ready for this, and I'm calm, and I'm just living my life now.

If you spend your life worrying all the time, it's no good. Enjoy life while you can.

getyourselfconnected said...

I think the anon poster is Kevin from my blog. That guy sees things so clearly, I wish he would write.
if you are reading, you can have an open forum on my site anytime.

Jeff said...


It's funny with the anon's.

I see awesome responses as well as angry attacks. It think it's pretty funny.

Last year during the Bear Stearns rally last spring I took a lot of heat being bearish on equities.

When then collapse occured the haters went away.

I am seeing the same thing now after our current 50% rally.

The bulls are once again emboldned as they get led to slaughter.

That's ok I have no problem with free speech

Anonymous said...

"Jeff said...The bulls are once again emboldned as they get led to slaughter."

Just trying to keep you honest jeff.

3 years ago, when stocks were high, I was bearish. As they got very cheap in late 2008, I turned bullish. As they sit in late 2009, I am turning bearish again.

In that time period, youve been nothing but a bear. You saw the same screaming decline we all did in March 09 and concluded we arent near the bottom and have a long ways to go. That is the mark of a permabear. You readers should know this about you.