Fin/Inv

Itulip had a very interesting update yesterday. I wanted to start with a few comments on the markets before I get into it:

First of all, I apologize for not discussing the markets too much this week. At this point in time I see no sense in doing so. The recent moves both up and down have been pretty much meaningless because there is no volume behind them. This lack of confirmation means that you must take them with a grain of salt.

The market is basically flat for the week after today. I haven't seen much T&A that has been particularly helpful in the last few weeks. Technical analysis without volume is a very dangerous game to play in a market like this.

The way I see it: The bears and bulls are both frustrated at this point. The bulls want a pullback because the entry points at these elevated levels are too pricey for even their expensive tastes. The bears also want a pullback because they are bears!

The light volume as both sides wait for a pullback has resulted in a market that is about as exciting as watching paint dry.

Stealth Inflation

Lets get back to the Itulip data. Eric made some great points around inflation over there. Is the deflation we all believe we are seeing actually a mirage? Stealth inflation is the idea that you make products of lower quality and sell them at the same price as previous higher quality products.

Hmmm.....

Could it be that we are slowly sinking into third world living conditions as the quality of our products deteriorate in order to make them affordable for our battered consumer?

Are the 12oz steaks that we enjoyed last year slowly being replaced by 10 oz steaks at the same price? Or will the quality of beef eventually deteriorate without the consumer knowing it as prices remain the same. I have been hearing rumors that certian so called "Prime Steakhouses" are now buying choice beef and pricing it slightly below prime without telling their patrons.

Another question around inflation:

Will a dramatic drop in supply as factories go BK actually force prices higher as products become more scarce?

These are all excellent questions, and stealth inflation in the form of cheaper made knockoffs and smaller portions may be a serious part of the equation.

I have to believe that the fight between the deflationist's and the inflationist's will end up ending somewhere in the middle.

I compare this situation to politics. Each side makes great points but neither side is always right. The far left Democrats and the far right Republicans are both a bunch of loons. As a result, most bills that get done in Washington end up somewhere in the middle.

Here are a few graphs that support the idea that we are in a period of disinflation versus deflation(similiar to periods of the '70's):

Here is the CPI during deflation of the 1930's:


Here is the CPI in our current collapse:

My Take:

The way I see it, four months is not a long enough period for the inflationist's to declare victory. To their credit, the Fed has not let them down yet as they create trillions of dollars in order to keep this bubble afloat. However, if they cannot sustain these shenanigans, will we see the collapse like the one seen above from the '30's?

One thing is certianly becoming more and more clear to me. Our living standards will steadily drop in either scenario. If we cannot afford price inflation, then we will likely see inflation via cheaper goods replacing superior goods at the same price.

I am seeing signs of the new third world America right now. Outback now has a 6oz steak for $9.99. Five years ago, America would have laughed at them if they tried to call this a "steak dinner". Today, its a reality.

The inflation/deflation debate will rage on long after I finish this post. However, I thought that Itulip made some great points today around a potential lack of supply as well as the quality of supply.

The falling dollar, a deflation obsessed Fed, and changes in quantity as well as the quality of supply are all compelling reasons to see the inflationary side of this equation.

On the flip side, bankers always lose in severe inflation because all of those dollars they own become worthless. As a result, the bankers and the Fed want some inflation but not TOO much inflation. They may decide that deflation is the only exit where they remain rich because the dollar would rise in such a scenario.

Its a tough argument folks! This is why a well diversified portfolio should be prepared for either scenario.

I have written before that the inflation vs. deflation bet is likely the Call of the Decade.

That topic is becoming hot. I have had several exchanges in the last few days about the inflation vs. deflation outlook for the economy. Some have pointed to Barry Ritholtz’s post at Big Picture indicating that deflation currently has the upper hand. Dave Rosenberg also pointed to the same theme today.

On the other hand, Warren Buffett wrote an op-ed in the New York Times warning of the risks of USD devaluation and debasement should the US government continue on its current trajectory of deficit spending, which would lead to inflation for US residents.

I will repeat what I said to everyone that I discussed this topic with.

When I read the analysis, both camps are persuasive. Both camps are populated with some very smart investors (who wants to bet against Warren Buffett?)


Let the model decide
It is becoming evident that the future will be dominated by either inflation/hyper-inflation/USD devaluation, or deflation, but little in between. In this case, I would prefer to allow a trend following model do its work and tell me which way the wind is blowing (see an explanation of the model here).

In our asset allocation road map for the next 12 months I stated the following:

Here is real income growth for households since 1980 in 2007 dollars showing the mean value for income in each quintile and the mean income for the top 5%, as found in the US Census Bureau Historical Income Tables - Households (Table H-3).


Link US Census data



Cost plot courtesy of Wiki, the spread above the CPI line shows how much real costs grew, and compare those rates to the real income growth rates above. The bow on the package would be debt, and the growth in debt service payments.
Link Wiki Inlation, Tuition, Medical Cares since 1978

FN: Chinese stock hit that magical 20% peak to trough decline and are now in a "Bear Market"... again. Like I said yesterday: Parabolic Moves Always End in Tears.

Stocks Fall as China Slumps; Commodities Drop, Yen, Bonds Rise: "China’s stocks dropped, briefly dragging the benchmark index into a so-called bear market and triggering declines in equities and commodities worldwide. The yen and Treasuries rose as investors sought less risky assets.

The MSCI World Index of 23 developed nations sank 0.4 percent at 8:54 a.m. in New York and futures on the Standard & Poor’s 500 Index slid 1.1 percent. China’s Shanghai Composite Index slumped as much as 5.1 percent, extending its drop from a 2009 high to more than 20 percent, the common definition of a bear market. Copper fell 3.3 percent. The yen strengthened against all 16 of the most-traded currencies tracked by Bloomberg and the pound weakened. The 10-year Treasury yield dropped to its lowest level since July 14.

The U.S. and Chinese governments pledged more than $13 trillion to combat the worst financial crisis since the Great Depression, helping to fuel a nine-month rally in the Shanghai Composite that pushed the index’s price-to-earnings ratio to almost double the valuations for the S&P 500, according to data compiled by Bloomberg. Earnings for Chinese companies that reported since July 8 have trailed analysts’ estimates by 12 percent on average, Bloomberg data show."

With all the competition in the market for mid- and low-priced homes, Yun said there are reasons for potential homebuyers to be optimistic about the current market.

“People who are buying today might see a home equity gain a year from now,” he said. “Further decline in prices could be minimal -- if there are price declines at all.” (San Diego Source)

What is this statement supposed to be? Spin. More Spin. Another inane statement from Lawrence Yun, who is the Chief Economist for the National Association of Realtors.

Here's an interview with Karen Weaver, one of the Deutsche Bank analysts who predicts that 48% of all mortgage borrowers will be underwater by 2011.

Here's an sampling:

The obvious takeaway of falling home prices and being underwater is what it does for defaults. But there's a bigger implication, which is that when we look at the economy over the past decade or two, it's been very much a consumer economy.

What has been driving the consumer hasn't been gains in incomes. What has been driving them is easy credit and rising home values. And the fact that their home price was rising and they could borrow against that through home equity lines or loans or refinancing, it augurs for a very different economy going forward if people don't have that option.

Now we know why the rally can’t pick up any volume: pension funds, which manage $3 trillion in assets are shunning stocks. Bloomberg story here.

Is it 1934 or 2009?

All I could say was WOW when I read this. This gave me chills. The similarities here are simply breathtaking. The cartoon below was published in the Chicago Tribune in 1934.

History repeats itself folks. You hear me say it on here all the time. Any bulltard that tells you "but its different this time" when this crisis is compared to The Great Depression is kidding themselves.

You can through that line right in the same trash can as these other famous quotes over the last few years:

"Real estate always goes up!"
"Subprime is contained!"
"There is no housing bubble!"
"The recession is over!"

Substitute the names with our current group of clueless leaders and you could have published the same cartoon in this week's Chicago Tribune and no one would have batted an eye.

I was hoping that we would have learned from our mistakes. Apparently Not: