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Andy Xie's thoughts often closely match that of my own. We've had another sighting over at Naked Capitalism. Must read!
Guest Post: Andy Xie - "Markets Are Trading On Imagination"
Here's a quote to wet your appetite, but the entire article is well worth a read.
Rising oil prices, though, lead to inflation and depress growth. It is a stagflation factor. If the Fed doesn't rein in weak dollar expectations, stagflation will arrive sooner than I previously expected.
Here's a previous link that's a modest summary of his previous predictions.
May 7, 2009
More from Andy Xie
Real Estate Newsletter Articles this Week: Existing-Home Sales Increased to
4.15 million SAAR in November
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At the Calculated Risk Real Estate Newsletter this week:
[image: Existing Home Sales]*Click on graph for larger image.*
• NAR: Existing-Home Sales Increase...
11 hours ago
28 comments:
I wet my whistle but I whet my appetite.
Dearieme,
Oops! I knew whet was a sharpening term but I had no idea whet was also for appetites too. Learn something new every day.
Mark,
At least Deartime didn't whet their pants.
One mans Stagflation is another mans inflation which in turn leads to another mans deflation.
Spinning Wheel
http://www.youtube.com/watch?v=qi9sLkyhhlE
Kevin
Stag,
That Andy X. article dampened my appetite (for wall steet financial products and risk).
Speaking of sharpening terms, the word "whittle" as a noun is a knife. As a verb, "whittle" basically means to dwindle or reduce away gradually.
Nest eggs, frogs in pots and sheep getting slaughtered come to mind.
By my count, stocks have underperformed long term treasuries for four decades. And that's after $14 trillion in guarantees and bailouts. The greatest story never told!
Kevin,
You got no money, and you, you got no home
Spinning wheel all alone
It's the housing bust song! Nice!
mab,
I have this uneasy feeling that non-inflation Treasuries and stocks will be fighting over the title of worst investment during the next four decades.
Siegel would have us believe that stocks are cheap relative to treasuries. Maybe they are. That doesn't necessarily mean that stocks are cheap though.
Are stocks cheap relative to oil? In 40 years we can use hindsight to find out. I suspect that we might not like the answer.
http://illusionofprosperity.blogspot.com/2007/10/predictions-of-doom-chart.html
That top chart...it's a bear. Maybe we can mad maximize our economy though using even more financial innovation. Sigh.
Stag,
I have this uneasy feeling that non-inflation Treasuries and stocks will be fighting over the title of worst investment during the next four decades.
I know I'm a heretic for saying this, but inflation is good for stocks, especially in the long run. Prior to the implementation of inflationary policies, stocks were not good investments. That said, I don't see big inflation ahead, at least for the next few years.
As for 40 years, who knows? At the recent 4% yield, I thought the 10 yr treasury looked attractive. As for the 2% yield on the 10 yr treasury a few months ago - why bother.
The insurance provided by the 10 yr TIPS still look good to me. Just in case.
mab,
"I know I'm a heretic for saying this, but inflation is good for stocks, especially in the long run."
Only if inflation doesn't reach the magical breaking point (where it causes massive pain to anyone not hoarding).
http://www.geam.com/common/newsdocs/wp_summer2005.pdf
"Historically, equities have been considered a good inflation hedge, yet the historical correlation between equity returns and inflation does not support this (Figure 4). Figure 4 shows that correlations are actually negative for most of the observed period, suggesting that equity performance deteriorates as inflation rises, in both real and nominal terms. Pension funds, particularly those with liabilities sensitive to inflation, may consider a strategic allocation to TIPS as an inflation hedge."
See Also: 1970s
Stag,
You shared the GE paper on TIPS with me before. Very informative.
Only if inflation doesn't reach the magical breaking point.
That magical breaking point might lower the price/valuation of stocks, but that doesn't mean it lowers their value. Just the opposite occurs imo (at least in in nominal terms).
Warning! The following thoughts are based on my own research. Go ahead and be skeptical, I'm no genius. Also, criticism is welcomed.
Here's my quick and dirty synopsis.
Since 1913, we've had three elevated/sustained periods of inflation - around WWI, WW2 & the 1970s. Each of these bouts with inflation caused equities to tank below fair value (I'll skip the reasons why for now). Anyway, after tanking, as the inflation rate started decreasing, all the inflationary (excess) dollars eventually found their way into earnings which then led to an equities rally and eventually over-valued equity markets. Equity booms and busts are nothing new. The WW1 inflation was actually followed by a deflation which killed stocks, but the result was basically the same - bust followed by boom.
If you have the patience and can stomach volatility, the tax defered nature of equities is a great place to hide from inflation, provided you buy at low valuations (say 4% dividend yields or single digit P/E ratios). Also assuming you don't have a deflation.
I have another condition for equities - a functioning/growing economy. A necessary condition for a functioning economy is reasonable debt levels.
The fed doesn't make available any data on debt levels during WW1, but I suspect they were much lower than today's levels. In any event, the inflation was followed by a deflation and a huge equity bust.
Debt levels after the 1920s stock boom were at historic highs, especially considering that we were on a hard gold standard whereby people could opt out and shelter their wealth from the welfare state - KA-BOOM!
After the WW2 inflation, debt levels (especially household debt levels) were at historic lows as were equity valuations - KA-CHING! Equities were the place to be. They overshot to the upside - of course.
That brings us to the 1970s/1980s. Debt levels were not low, but they weren't stupid high either. However, due a new credit system and a new way of thinking, we were able to kick start credit like never before. CPI inflation was high in the 70s, but I think irrationaly so (blame the hoarders and the Arabs). End demand for goods was high due to financial liberalization and demographics. Wages increased with inflation and credit made up the short fall in real wages. Equities rallied from historically low valuations and then boomed. You know the rest of the story.
I think today's debt levels are stupidly high. Especially household debt. We're teetering on Oct. 1929. But, they won't allow a deflation so I'll call it 1989 Japan. The big differences between today and the 1970s are debt levels, demographics, and end demand. Add in global wage arbitrage and I just don't see much inflation.
I could be wrong about forward inflation of course. Regardless, I'm not buying the green shoots bs and I'm certainly not buying stocks at these valutions. The 1929 deflation obliterated stocks from even lower valuations and debt levels. Same thing with the WWI deflation.
Great article by Andy. Thanks for the link. I have always appreciated his straight forward and simple language.
Like this: The Greenspan era has nurtured a vast financial sector. All the people in this business need something to do. Since they invest other people's money, they are biased toward bullish sentiment. Otherwise, if they say it's all bad, their investors will take back the money, and they will lose their jobs. Governments know that, and create noise to give them excuses to be bullish.
And this: It is astonishing that a value-destroying industry has lasted so long. The greater irony is that salaries in this industry have been two to three times above what's paid in other sector. The key to its survival is volatility. As markets collapse and surge, possibilities for getting rich quickly are created. Unfortunately, most people don't get out when markets are high, as they are now. They only take a ride.
And the clincher: Indeed, most people who invest in the stock market get poorer.
Crystal clear. Nowhere to hide. Love it!
Thanks for your blog. I come here often for your perspective. Keep it up!
mab,
http://illusionofprosperity.blogspot.com/2007/09/warren-buffett-on-1970s-inflation.html
Buffett goes into great detail how the inflation of the 1970s was causing extreme pain to companies back and how marginal companies simply could not survive it.
The inflation tapeworm is a tax that helps government at the expense of all others. No free lunches. We feel pain as workers because wages can't keep up. Similarly, companies feel pain as earnings can't keep up.
Just my opinion of course. Hopefully we won't have to test my opinion in a real world situation any time soon!
Anonymous,
"It is astonishing that a value-destroying industry has lasted so long."
Las Vegas! Reno!
Lots of volatility. Lots of leveraged longshots. House takes its cut, offers some complimentary drinks from time to time.
Wall Street!
Lots of volatility. Lots of leveraged longshots. Financial institutions take their cut, offer some complimentary online option trading seminars from time to time.
I wish I was joking. Sigh.
mab,
Here's a paticularly concerning qoute from Buffet inthat last link.
"Our acquisition preferences run toward businesses that generate cash, not those that consume it. As inflation intensifies, more and more companies find that they must spend all funds they generate internally just to maintain their existing physical volume of business. There is a certain mirage-like quality to such operations.However attractive the earnings numbers, we remain leery of businesses that never seem able to convert such pretty numbers into no-strings-attached cash."
Sorry for the spelling errors. I'm using a playstation controller without adequate sleep. D'oh!
mab,
One more thought. If I knew for sure inflation was coming I certainly wouldn't be sitting in TIPS.
The "negflation" concept does make some sense to me. If the Fed wants 2% inflation and the price of oil rises, then something else will be deflating to offset it, again.
I'd be doing just fine as a saver if inflation averaged -1.7% (deflation) and my TIPS pay a real rate of 1.7%. It would be almost like simply burying cash. I'd owe a hint of taxes on the interest each year, but my tax bracket would make it negligible. Further, over time the deflation protection would kick in.
Any inflation rate above that only hurts me, but perhaps not as much as others.
Stag,
I've read all of Buffett's annual reports for Berkshire. I've also read many of his other comments and pieces.
I've noticed Buffett's view of inflation changed as time passed. During the rising inflation, he noticed the tapeworm. During the declining inflation, he reaped his reward.
Inflation over the past 10 years has been ~ 2.5% annually. Compare Buffett's returns during that low inflationary period to his returns during prior periods of high(er) inflation. Based on his diminishing returns, I can understand why his views have changed.
Buffett has never invested during an extended peroid of deflation or even zero inflation. If the mild deflation of the past year is any indication, he'll be begging for a return of the tapeworm soon.
Gotta run. I'll dig up some more back-up for my thesis.
I appreciate your feedback. The issue is not quite settled in my mind.
Las Vegas! Reno!
Lots of volatility. Lots of leveraged longshots. House takes its cut, offers some complimentary drinks from time to time.
Wall Street!
Lots of volatility. Lots of leveraged longshots. Financial institutions take their cut, offer some complimentary online option trading seminars from time to time.
Gamblers anonymous!
"Unfortunately, most people [gamblers] don't get out when [they're still ahead]."
"Indeed, most people [gamblers] who invest [gamble] in the stock market [casino] get poorer."
Andy Xie is like a child stating the obvious in a crowd of people who must pretend that it's not obvious.
mab,
If nothing else, consider...
The stable currency of the 1980s and 1990s was a great time to own stocks.
Toggling between high inflation ($140+ oil) and deflation (crashing housing prices) creates panic and uncertainty.
Speaking from my own gut, I don't feel that we're even remotely done toggling yet.
Perhaps the worst part of both eras was the massive change in inflation expectations. It's easy to see how half of investors/companies could end up on the wrong side of that trade/hedge.
Take Buffett. He's always worried about inflation. He bought oil and banks even though he saw the housing bubble. Oops!
Massive inflation expectation toggling just adds one more risk to an already risky system.
And lastly, you argued that inflation in the 1970s made stocks trade below fair value. I agree. However, I can only agree in hindsight. The inflation monster was eventually tamed. Had it not been tamed, stocks could have easily been overvalued. Had it required a wheelbarrow of money to buy a loaf of bread, I'd much rather have been a bread hoarder than a bread company paper stock hoarder. I would not have been alone. Just sayin'.
Anonymous,
"Andy Xie is like a child stating the obvious in a crowd of people who must pretend that it's not obvious."
Nice analogy!
Stag,
However, I can only agree in hindsight.
Yeah, my hindsight is 20/20 too. However, there were some indicators that stocks wouldn't get hyper-inflated to oblivion. For one, real earnings for the S&P 500 increased nicely during the 1970s (~30%). And real earnings actually fell during the 1980s. Credit booms do wonders for asset prices. I still maintain that Buffett changed his tune regarding stocks and inflation.
I think the abandonment of the gold standard both caused and exacerbated inflation fears during the 1970s. Under the gold standard, I'm not even sure there was such a thing as "inflation expectations" as long run inflation didn't really exist. Without gold, people had very real reasons to fear runaway inflation.
One more point. Since 1913, we've had two prior deflations. The first was a CPI deflation (and maybe a credit deflation) after the WW1 inflation. The second was a CPI and credit deflation after 1929. The 1920s were not CPI inflationary. Both deflations were horrible for stocks. I'm pretty sure credit deflations and stock busts go hand in hand. I'm also pretty sure that inflation is a key driver of stock prices over the longer turn.
mab,
Can't argue with any of that.
As long as inflation expectations don't become runaway (hyperinflation) expectations, then inflation is good for stocks.
Further, deflation is never good for stocks. I think that pretty much goes without saying. It stands to reason that inflation must be good for stocks, since inflation is deflation's opposite.
That being said, if inflation rose a million percent next year the stock market would no doubt rise in nominal terms, but I doubt very much it would rise anywhere near a million percent. There would be blood in the streets (main street AND Wall Street). The biggest discretionary economy in the history of mankind would cease to function. Who would visit Disneyland? Who would eat out? Who would continue on as if nothing had changed?
Stag,
If inflation rises a million percent next year, you're going to owe a shed load in taxes! ;)
I meant to add this:
From 1871 until 1932, excluding dividends, stock returns were negative! Of course dividends were often > than 5% (vs. long treaury rates of ~ 3% to 4%) to compensate for the higher risk. Creative destruction was alive and well. However, the high dividends did provide decent returns for those with a sense of value.
Prior to inflation, it was a stocks for dividends mentality, not stocks for the long run. And for good reasons.
Can't argue with any of that.
That begs a question. Can Bernanke successfully inflate from here? On a CPI basis? On an aggregate credit basis?
So far the issue is still in doubt. Since the crisis began, aggregate credit has stalled (per flow of funds). And nominal GDP and CPI have declined!
Zombie banks? We may have a Zombie eCONomy. Or a pending black hole eCONomy. We need the re-animator.
I'm still very uncomfortable.
mab,
"Can Bernanke successfully inflate from here?"
Here's the main problem my gut has with long-term deflation.
We send massive unsustainable amounts of paper IOU dollars overseas in exchange for cheap real goods. I just have a hard time thinking that the end game for that will be even cheaper goods.
Stag,
I just have a hard time thinking that the end game for that will be even cheaper goods.
I held that view for a long time. And part of me is still clinging to that line of thinking. But the natural tendency is for declining prices. I think demand for goods, and, more importantly, credit is in the intensive care unit. I do not see a quick recovery either. Too many with too much debt.
I can't ignore all those people making < $100K/yr that were living like millionaires for years. They are facing a new reality.
The top 1% of income earners make ~ $325K/yr. After taxes, say the top 1% bring home $195K (40% in taxes). If they save 25% of their take home income (~$50K), it would take 20 years (in real terms) to become a millionaire. And even then, a millionaire would be facing a severe drop in disposable income upon retirement.
It seems to me that to become a millionaire, you can't live like a millionaire - ever in many cases.
Financial heartache ahead for many.
mab,
"It seems to me that to become a millionaire, you can't live like a millionaire - ever in many cases."
I posted that same thought on maxedoutmama recently.
I live like a millionaire if...
$25,000 x 40 years = $1 million
I think it's why many lottery winners eventually go bankrupt. If you win a million and quit your job you better spend like a frugal miser OR pray your investments generate positive real rates of return.
Using hindsight, the last 10 years have been most unkind to the Something-For-Nothing crowd. Not too bad for the Penny-Saved-Is-Penny-Earned crowd though, at least by comparison.
Stag,
OR pray your investments generate positive real rates of return.
Maybe we need to pray harder.
From 1930 until 1940, the S&P 500 fell from ~ 22 to 12. However, with dividends and deflation of 2% annually, stocks posted annualized real returns of 1.88% for the decade.
Any student of the Great Depression will tell you how bad things were and make compelling arguments as to why we can't allow another depression to occur.
From 1/1/2000 through 5/1/2009, the S&P 500 has posted annualized real returns of -5.51%! Nominal annualized returns have been -3.09%.
Despite losses greater than those of the "Great Depression", many have managed to live like millionaires. How? Debt!
I'm long hand baskets.
mab,
"I'm long hand baskets."
Maybe we'll run out of cheap energy and the hand baskets will come to an abrupt halt before we reach our destination?
Perhaps we'll be living the good life in hand baskets for all of eternity.
See? I'm an optimist!
Stag,
Maybe we'll run out of cheap energy and the hand baskets will come to an abrupt halt before we reach our destination?
Or maybe we'll just go "green" and over "shoot".
Fasten your seat belts and keep your hands and feet inside the hand basket at all times. This is not a drill.
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