Monday, August 22, 2011

Stagnationary Prediction Update

June 25, 2010
My Stagnationary Prediction



In my last post I concluded that the stimulus physics model I was using is beginning to break down. I clearly need to start thinking of another model to replace it. The most obvious path is that the stock market just continues to roll over. It is hard to believe in the obvious though. I typed "double dip" in Google and it actually tried to help me by adding "recession 2010" to the end of it. Go figure.

The DJIA is trading at roughly the same level that it was trading at when I turned bearish in 2004. That was my primary fear in 2004. It would simply stagnate. That's my primary fear now.

My long-term prediction is therefore just about as simplistic as simplistic could be. Hello stagnation. It's just a gut call. I don't have much supporting evidence to back it up. Just add one part deflation to one part stagflation and that's what you get though.


We are now off the chart to the right and a mere 354 points from the line established by the red arrow.

Mission accomplished!

In all seriousness, I offer this thought experiment as the basis for my long-term prediction.

If you were in charge of kicking economic cans down the road and you knew for certain that our standard of living would fall no matter what you did, then what path would you choose to get us there?

If it was me and I was into kicking economic cans down the road, then I would shoot for stagnation in the stock market. I'd keep prices flat and allow the slow grind of inflation to do all the work for me.

Why?

1. A slow grind creates less turmoil than massive losses all at once. There is less chance for panic.
2. With hundreds of trillions of dollars of derivatives in existence, flat would seem safest. Change creates stress. Stagnation is the very essence of non-change.
3. Those long the market would adjust slowly to the new reality.
4. Those short the market would have a harder time making out like bandits.

In nominal terms, the stock market was flat during the 1970s. It was also flat in the 2000s. I do not necessarily think this is a coincidence.

That said, there is a lot of risk out there right now. This is more of a long-term prediction. Anything can happen in the short-term. This Christmas season comes to mind. Sigh.

15 comments:

GawainsGhost said...

So basically what you're talking about is market manipulation, not market correction.

But there will be a market correction eventually. When you've got overvalued assets, overpriced houses, high unemployment, depressed wages, a wildly fluctuating stock market, insolvent banks, insurmountable debt, and turmoil around the world, it's only a matter of time.

I really don't think the next decade will be very kind.

Stagflationary Mark said...

GawainsGhost,

Stagnation can be its own form of market correction.

Consider that the end result of the following two situations are pretty much the same.

1. Asset prices drop all at once and instantly correct.
2. Asset prices stay flat for decades but fall slowly in inflation adjusted terms.

#1 is like ripping off a Band-Aid.
#2 is like pulling the Band-Aid off very slowly.

I generally pick #1 when I'm doing it. Some prefer the slow grind. Go figure.

That said, I do not think we're doing a very good job emulating #2. We're actually racking up inflation adjusted debt. Sigh.

I really don't think the next decade will be very kind.

I hear that. I am more bearish now than I was in 2004. I believe those who think the worst is behind us will be very disappointed.

Jazzbumpa said...

In nominal terms, the stock market was flat during the 1970s. It was also flat in the 2000s. I do not necessarily think this is a coincidence.

The nominal was grossly misleading in the 70's as stock values were ravaged by inflation. Not so the the naughts, when inflation was quite tame.

The 70's were part of a 16 to 18 year long decline in real stock values that preceded the greatest speculative boom in history - a nominal 14x expansion in about 25 years.

The difference now, in my view, is that the last decade plus has been a long topping pattern - a gigantic head and shoulders formation spanning over a decade. A smaller triple top made from the Feb, May and July peaks just ended, and a year-long support channel was broken.

Once the DJI breaks through the longer trading channel going back to at least 1982, there is no support level this side of 1000.

And deflation seems a likely outcome
I am very, very afraid.

Sadly,
JzB

Stagflationary Mark said...

Jazzbumpa,

The nominal was grossly misleading in the 70's as stock values were ravaged by inflation.

Indeed. People generally do not factor in the effects of inflation/deflation like they should. I know of people who would rather earn 10% with 10% inflation than 0% with 0% inflation. The numbers might be bigger but it makes no sense. The latter is much better for the investor. There's nothing for the government to tax.

Not so the the naughts, when inflation was quite tame.

Even tame inflation can pile up (compound) though. Consumer prices are up 33% since January of 2000.

And deflation seems a likely outcome
I am very, very afraid.


I hear you. It is a non-trivial risk and I do still lean deflationary in the short-term.

One reason I still like I-Bonds even at the 0.0% real rate is for the deflation protection. They cannot lose so much as a penny in nominal terms from month to month.

Stagflationary Mark said...

One more thought.

Heaven help us all if this long-term stagnationary prediction ends up being way too optimistic.

Who Struck John said...

Mark, your data above does look more parabolic than asymptotic.

getyourselfconnected said...

"predictions are always difficult, especially about the future!"- yogi berra

Any idea on what Beranke does this Friday at Jackson Hole?

Mr Slippery said...

I am astounded by the bulls on TV right now. I see nothing but world changing risks across every ocean and in the US. Too many to list.

I have colleagues who listen to their financial advisers and are allocated 70% in stock index funds and the rest in medium term bond funds. They have been savaged in the last few weeks and it has never occurred to them to move something into cash. Deer in the headlights syndrome.

I am not happy about the gold spike even though I hold some. It makes me nervous, starting to feel like a mania. Where else can you go? I've got my allocation of 0% i-bonds already. I don't want TIPS at negative or less than 1% rates.

I think there might be some good utility stock buys in the next couple of months, but picking a bottom is very hard.

Bah! Maybe I'll go back to nickels.

Stagflationary Mark said...

Who Struck John,

Mark, your data above does look more parabolic than asymptotic.

Would you settle for asymptomatic?

In medicine, a disease is considered asymptomatic if a patient is a carrier for a disease or infection but experiences no symptoms.

Hmmm. Perhaps that's not quite right either. Never mind.

Stagflationary Mark said...

GYSC,

I predict that he'll end 15 over par, mainly because two of his balls went underwater.

Jackson Hole Golf

Course highlights include water hazards on 11 of the 18 holes...

Shame on me! ;)

Stagflationary Mark said...

Mr Slippery,

I have colleagues who listen to their financial advisers and are allocated 70% in stock index funds and the rest in medium term bond funds. They have been savaged in the last few weeks and it has never occurred to them to move something into cash. Deer in the headlights syndrome.

Cash can't make you filthy stinking rich though! And as we all know, America has 200+ years of filthy stinking rich creation history. It's bound to continue. What could possibly stop it?

On a related note, is it possible to be too sarcastic?

Audrey said...

Nice post. An analogy might be a family where the parents lose their jobs but don't want to let on to the kids, so they just stretch out the credit as long as possible and make like things are fine. Just on a much bigger scale. And the "parents" are everyone - the gov't, business, investors - as they all realize there is not really an alternate route. All roads lead down. Might as well postpone the ride...

Stagflationary Mark said...

Audrey,

Extend and pretend!

fried said...

I agree with Mr. Slippery. I have gold and silver, and they are running too fast for me...and the silver smackdown in May is a reminder of what margin hikes can do. I can't put any more into i-bonds, the rest is in m market treasury funds at Vanguard.
But I'm getting killed on an oil fund from Vanguard...waiting to see if it pops after Ben speaks on Friday. If I could dump the whole lot into i-bonds tomorrow and walk away, I would be much happier.

Stagflationary Mark said...

fried,

In 2000 I would have put my entire nest egg into 3.4% I-Bonds had I been allowed and told friends that very thing.

I'd do it today even at 0.0%. I wouldn't even think twice.

I strongly believe the government knows it too. It has known since the very month we entered the recession.