Thursday, August 12, 2010

Wall St Goes Long Deflation

I thought I would start with a little video from Gary Shilling who has been calling for deflation since this crisis started in 2007.

Gary does a great job here explaining why deflationary is so devastating and also gives some great advice on how to invest in a deflationary environment:

My Take:

Gary pretty much nails it.  It appears the street was listening if you look at today's 30 year bond auction:

"NEW YORK (MarketWatch) -- The Treasury Department sold $16 billion in 30-year bonds on Thursday at a yield of 3.954%, the lowest since March 2009. Investors offered to buy 2.77 times the amount of debt sold, compared to an average of 2.44 times at the last four new sales of 30-year bonds /quotes/comstock/31*!ust30y (UST30Y 3.94, +0.02, +0.43%) . Indirect bidders, a group that includes foreign central banks, purchased 46% of the auction, versus 38.3% of recent sales, on average. Direct bidders, a class that includes domestic money managers, bought another 18.6%, compared to 16.7% on average. The broader bond market remained lower after the auction, the last of the week. Yields on 10-year notes /quotes/comstock/31*!ust10y (UST10Y 2.75, +0.06, +2.12%) , which move inversely to prices, rose 2 basis points to 2.74%."

Take Continued

I'll be honest here.  I was glad to see this auction go so well.  I had posted on here a few days ago that the the Fed may have incited a panic by avoiding the 30 year bond with it's announced purchasing of treasuries.

After getting a chance to digest the FOMC announcement I became less concerned because the Fed is not going to be purchasing huge amounts of bonds.  I believe the number is only about $20 billion a month.

The feeding frenzy seen in the 30 year auction today pretty much confirms that the fear of deflation overrides anything the Fed announces which is kinda scary when you think about it.

Perhaps the market is beginning to tune out the Fed and as they begin focusing on the deflationary mess we have gotten ourselves into?

I believe so.  The fact this auction went so well tells me that some investors consider the Fed to be impotent at this point.

They are smart if they start looking at the Fed in this light.  There really isn't anything else they can do at this point.  If they do QE(and I am sure they will at some point) it's not really going to matter because none of the money can get into the real economy.

It's pretty clear that the banks have no desire to lend at this point.  Why waste the money if it can't get into the economy. 

Common sense doesn't matter here though because the Fed is obsessed with stopping deflation so I full expect more quantative easing. 

Another QE would just be another win for the banks and another loss for Main St because we are the ones that have to pay it off.  Should we be surprised at this point?

The bottom line here is the money supply will still shrink either way because it cannot expand unless people and companies are borrowing the money and putting it into circulation. 

The Bottom Line

The bond market told you that the deflation trade is still definitely on.  The Fed's treasury purchases probably aren't even needed at this point as the economic data continues to spell deflation.

Perhaps they should use this money to pay down our national debt instead of wasting it on securities that already have high demand. 

Maybe they should sock the money away and use it to feed the millions of unemployed as they run out of their 99 week of jobless benefits. 

God knows we will need it after seeing the today's weekly jobs report:

From Haver:

"The bad news about the labor market continued today. The Labor Department's report that initial claims for jobless insurance rose to 484,000 last week from an upwardly revised 482,000 brought them to the highest level since February. The four-week moving average of initial claims which smoothes out some of the w/w volatility rose to 473,500, also the highest level since February."

Get ready for a lost decade folks.  It's heading straight towards us like a freight train. 

The only way to play this in the markets is to get out of stocks as Gary says and either buy bonds or short stocks over the longer term.

Going short can be very difficult to stomach at times because you have to fight constant government interventions as well as the slick Wall St trading wizards/HFT traders so enter this trade at your own risk.

I am still bullish on bonds.   Yields should keep dropping now that the Fed has spoken.  The only risk here is if the bond market begins to focus on our deficits and starts taking rates higher.  If they do this we could pull a "Greece" rather quickly.

Cash will also be king in this deflationary environment as the money supply shrinks.  The dollar will buy you much more in this world than it does today.

Interestingly gold shot up today which was kinda strange.  Gold often struggles during deflationary times.  This tells me people are still very afraid and don't have a lot of confidence in anything right now.  I will hold onto the gold I own because I am scared too!

One other thing worth noting:  Technically speaking we had a Hindenburg Omen today.  This is not good if you are a bull.  Hindenburg's are made when a certain percentage of stocks hit 52 week new highs at the same time others are hitting 52 week new lows.

Historically this is ugly for the markets according to Wiki:

"Looking back at historical data, the probability of a move greater than 5% to the downside after a confirmed Hindenburg Omen was 77%, and usually takes place within the next forty-days."

Those are nice percentages if you want to go short.  I hope we see a nice bounce tomorrow because plan on buying some shorts on any upward move.  I plan on buying some SDS and a few PUT's because I love these odds. 

Disclosure:  No new positions at the time of publication.

No comments: