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.