Flopflation is the name of the game, folks, forget stagflation
I frequently see, for a year and a half now, worries of stagflation. Stagnant real economic growth combined with high inflation. This vile fate is to befall us due to the printing of heinous quantities of money by Ben Bernanke and the federal reserve. All this extra money will result in huge inflation which, in fact, is the goal as inflation is the only apparent cure to the civilized worlds debt issues.
I frequently see, for two years now, worries of deflation. Debt-deflation to be exact. It works like this: deleveraging (the paying down of debt) results in, quite literally, a reduction of the money supply. The worlds mood, what with recession and financial panic and all, has changed and people now want a low or at least managable amount of debt. Therefore they are paying down credit cards (fact), and other forms of debt (also fact). New construction has plummeted and that is a key form of increasing the money supply in a fractional-reserve banking system. And foreclosures are soaring, taking money out of the system. Further, governments are implementing austerity measures, are unable to spend as much as in the past, and trying to pay down debt. All this deleveraging is working to reduce the money supply and the fed just won't be able to print fast enough to overcome it.
Both theories are sensible enough and very good arguments have been made by both camps, and certainly my brief commentary above does not do justice to either argument. Gold - without a doubt the investment of the hour, the tower of power, the soup of the day, the thing everybody loves, the trend, the tech stock in 1997 of today - of course, is said by its beleivers to work gloriously whether we have inflation or deflation. It is, as has been observed by others, simply acting like a panic-barometer, a measure of discontent, and apparently any form of 'flation panics people and makes them feel discontent.
The inflation camp (currently winning bigtime) says to buy commodities. And lordie have commodities had quite a run here... I couldn't say that the inflationistas necessarily really like stocks, except commodity related stocks, but perhaps they don't hate them.
The deflation camp (losing badly for the moment, but gloriously shining round about june of this year) says to hold debt, bonds, cash. They hate stocks and commodities.
Well here's my theory, let it be known that I have not read such a thing anywhere else before posting it here, and I'll start with why I think others have their theories and bits of what I think of them.
Ithink the inflationistas and the stagflation camp are pretty much just looking backwards. We had considerable inflation, and to no small extent, frankly, stagflation (excepting the housing bubble, we didn't have much economic growth in the '0x's) for the last 8-10 years. Pil, gold, etc have all surged, and economic growth has been weak. And, memories of stagflation from the tail end of the last commodity inflation cycle seem to ring in peoples minds, and so the inflationistas are essentially predicting a continuation of the trend (high inflation, starting/mostly in comomdities). What has been good lately? Thats whats going to be good in the future, and I think that the "zimbabwe/bernanke is printing" stuff is more justification for the belief that the trend will continue than it is deep logic.
Why do Ithink that? Because the deflationist case is probably more logical. Certainly the money supply isn't expanding radically, after all. And there is ALOT of deleveraging to go. Frankly, I support QE and QE2 and the basic keynesian mojo. Imperfect, sure, but whats perfect here? But thats a seperate debate...
And here is my thought for the next year, and perhaps the next several years...
We will continue to see combat between the inflationistas and the deflationoids. And no side will clearly win for some time to come. We had almost a capitulationto the inflationist camp in 2008, followed by a massive deflationary shock. We had a full year of inflationists winning from the march 09 bottoms to the april 2010 tops, following by a frightful (remember, folks, early summer 2010 was a terrifying time, even though people have forgotten that already) period of deflationists appearing to win. And now we are back into the inflation-is-inevitable mentality, sparked by qe2.
See... here is why the markets will continue to slosh back and forth between the two:
1. Deflation has some very real tailwinds. Including
a) the NEED and INEVITABILITY of continued deleveraging. Europes brain-dead, pie-in-the-sky liberal dreamers must pay for their sins, foreclosures have not ended, the housing market isn't likely to boom anytime soon, to some extent a more realistic attitude towards debt is probably going to semi-permanently (until the next time) set in.
b) Beyond that, and this is a HUGE factor, China is probably a preposterous bubble, and they are supplying a great deal of real demand for commodities and MUCH MROE IMPORTANTLY, that demand is supplying justification for speculators and "investors" to buy commodities left and right, create etf's, sell gold in vending machines, and generally create the universal knowledge that commodities can't lose. If China blew up, those speculators would run for the exits like fans at a Violent Femmes concert if the DEA showed up en masse and...
c) Commodity prices are NOT,in my vew, being supported by supply and demand but rather are being supported by speculation and "investment". Its people buying them in the view that they will go up that are making them go up. They are the ultimate momo trade, and if the momo comes off it'll get ugly quick. Just need a momo-killing catalyst...
d) the inflation trade runs up commod prices, which eventually will impair economic growth, which will lead to increased power for the forces of deflation
e) canada and australia and maybe more still have real estate situations that may end in pain
And all of this is set against the case for inflation which will, ultimately, in the end, prevail, which is
a) in the end the central banks will get their way and that means inflation, because its inflation that will ultimately help mitigate the debt issue... which is for the greater good, btw, as I have opined int he past.
b) the general tailwind for inflation that is global population and economic growth combined with finite resources
And so, to conclude, I offer you all the concept of "flopflation", where the world alternates between deflationary scares and inflationary panics for a time, and that is how I see the rest of this secular bear market playing out.
Buy the deflationary panics, Prechter et al won't be ultimately right. But sell super low VIX / high sentiment /inflationist victorydance rallies as they stall out. And remember, commodity inflation cycles (like the REALLY BIG ONE we have just seen, that is already veyr long in age) DON'T LAST FOREVER, and are generally followed by long periods of commodity price plateaus, equity bull markets, and extended real economic growth. We aren't just beginning to see commodity price inflation, folks, we've already seen it. Alot of it.
But also don't bet on the Prechteresque predictions of $10 oil and dow 1500, thats just silly. And the central banks will always intervene AS THEY SHOULD before we got that kind of mess.
And so the stage is set for flopping, all involving 'flation. Flopflation, if you please. The forces of delfation set in the ring against the momo trade (long term momo trade, the last decade) and the central banks.
But remember... we are still 20% below where the S&P was TEN YEARS AGO, so its not like it'd be ridiculous to see the market march significantly higher than it is today before this secular bear comes to and end, and in fact I would expect nothing less. But I also expect prices meaningfully lower than today at least once before the secular bear ends, and I expect one more cyclic-bear-20%-drop incident before the enxt ssecular bull.
And, frankly, in view of my expectation of flopflation and all of this, I suggest that simply buying the big dips will be the best course of action for the next couple of years. When adip is fresh, the best bargains exist. If we crash to 1250 from 1500, believe me, we will have better bargains than we have now after rallying extensively to 1250. This is because some sectors will crash more than others and represent deep value, where long rallies like this tend to flush out the deep values one way or another.
Thus it was predicted, may I be flogged if I am grossly wrong. I, for one, do not plan on aggressively shorting any rips. Just raising cash and taking hedges to prepare to buy the expected dips when they materialize.
And shorting, via an extensively calculate dand extremely shiny, numerous ETF combinations which must, in combination, fall in price as a "background strategy".
thank you, that is all