Remembering 1932: Deficits DO Matter!

What a day. Like that reversal? I wanted to go back in time today. Before i do that I wanted to talk about our current deficits and the market.

One of the keys of the bull thesis that triggered the rally in 2009 was that the budget deficits caused by bailouts didn't matter because the economy would turnaround as a result of the stimulus. As a result, the thinking was that we would then grow out of the deficits just like we had in the previous recessions seen since 1982.

I have consistently preached on here that Wall St has consistently underestimated the damage of the economic collapse of 2008. The above thesis was destined to fail becase the math didn't work this time aroundbecause the hole we dug ourselves into was simply too overwhelming from a debt perspective.

As stocks began to drop as a result of the 2007/08 collpase, the playbook of the previous recessions seen since 1982 was then predictably executed by the Fed and just about every financial advisor. The playbook was the usual: Lower interest rates as stocks drop and then buy your brains out once the market finds a bottom.

They also used another classic play out of recession playbook: Chase yields after the Fed lowers rates by gobbling up munies and high yielding bond funds thinking that "the worst is behind us".

Before you knew it, financial advisors were back in "buy and hold" mode after putting their clients "all in" into stocks and other risky investments.

This looked great back in 2009. Since then? Ummmm......Not so good!

In the previous 12 months this hasn't worked out so well. Stocks are essentially flat since last summer following the recent correction.

Financial advisors are now predictably beginning to panic. They don't know what to do because the majority of them have never seen a market this bad. The playbook doesn't tell them waht to do when their brilliant "buy and hold" strategy fails. Chaos then predictably ensues.

Sidebar:

You know it amazes me that any schlep with a college degree can get a job as a financial advisor by simply passing a test.

Is it just me that believes that it should require 6-8 years of business/economics schooling in order to become a financial advisor?

I mean shouldn't you at least have a masters degree in order to manage someones life savings? I mean Christ it takes a 6 year degree to become a licensed speech therapist. Grrrr...I will save this topic for another day.

Anyways back to my point:

I think the reason the volatility has been so high recently is because there is no "playbook" for what we are now witnessing in the markets. As a result, we are seeing wild swings in the market. A solid green day can become a red day in the blink of an eye. Today was a good example.

The biggest issue we have right now is there is nowhere safe to hide. I mean look at your two key options:

- Stocks? Yeah riiiiight....The P/E's are insane.

- Bonds? Deficits anyone? Look below.

"June 8 (Reuters) - The U.S. debt will top $13.6 trillion this year and climb to an estimated $19.6 trillion by 2015, according to a Treasury Department report to Congress.

BONDS GLOBAL MARKETS

The report that was sent to lawmakers Friday night with no fanfare said the ratio of debt to the gross domestic product would rise to 102 percent by 2015 from 93 percent this year."

My Take

Yeah OK that's sustainable(NOT!). 20 TRILLION? Is that all?(scarcasm off).

What I think we are about to see moving forward is something that we saw back in 1932 where there was no confidence in the safety of either stocks or bonds:


As you can see above, as stocks collapsed money flowed into bonds for the short term as investors flocked to safety. Bonds asa result did well for a period of time after the stock market collapsed.

However, as the economy collapsed and our deficits soared, investors decided that even bonds were not a safe place to be! The rest of course is history as The Great Depression gripped the nation for most of the rest of the decade.

Many decided that the best place for cash during this period was the mattress. Now I am not saying you should sleep on top of your money at this point. However, you know what they say about history.

The Bottom Line

Investors are scared and confused because they have never seen a crisis like this before. Even the pros are struggling with a market like this.

As a result, rallies are often sold into and volatility reigns supreme. This market is not for the faint of heart. My advice to all of you is to avoid getting involved. Buy a little gold and stay liquid.

I believe that it's time to also have some cash socked away at home. Nothing crazy: Maybe like 1-2k. I say this because things are extremely unstable in the European banking system. Because the world's banks are all so interconnected it means we are at risk.

I wouldn't be surprised to see an announcement of some type of "banking holiday" at some point so that the central bankers work everything out. Could this be next month or a year from now? Who knows? The risk nonetheless is there which is why I think you should be prepared with a little cash on the sidelines.

Hold on tight folks and please be careful. Things are bad and getting worse.

Disclosure: No new positions at the time of publication