Tuesday, April 20, 2010

A Few Things That I Believe: Observations From The Doc

* We are in a cyclical bull market within a secular bear market. The secular bear market began in 2000 and, like secular bear markets before this one (1929-1949; 1966-1982), this one could last for 15 years or so. Even after secular bear markets have put in price lows (1932, 1974), we've typically seen years of weakness and bottoming action until stocks become an unloved asset class. The March, 2009 may have been a price low for stocks, but we've got a way to go before stocks are a shunned investment.

* All that being said, we *are* in a cyclical bull market and only recently have we begun to see the kind of bullish sentiment extremes that might accompany a topping process. This bull market has lasted a little more than a year. Most bull markets last longer than that. I'm not convinced we'll roll over until there are stronger hints of a move away from low interest rates. The inability of traders and investors to recognize the difference between cyclical market moves and secular ones has created much pain for bulls and bears alike.

* I find it hard to believe that the Fed will have the political cover to raise interest rates until we see hard signs of inflation. That means that commodities might have to rally hard before we see the bull market in stocks roll over. If we're not overheating, I'm can't imagine the Fed raising rates in a high unemployment environment. So we stick with monetary ease until we overheat.

* A rise in long Treasury rates (decline in bond prices) will be a good tell for inflationary expectations and anticipation of overheating. As long as rates stay tame, it's hard for me to imagine stocks going to hell.

* I'm open to the possibility that all the above might be wrong and that the next driver of stock prices will be monetary tightening and a hard landing among emerging market economies. If the emerging nations stop serving as the engine of global economic growth, that's when we could see a second economic slowdown. I'm not convinced that the China miracle won't end up looking like the Japan miracle.

* I don't know how we emerge from burdensome debt other than to transition from being a consumption-driven economy to being an export-driven one. Over the long haul, growth-by-export will support a weak U.S. dollar, though any near term economic slowdown led by emerging markets would likely see a flight to the dollar.

* It is hard for me to imagine a transition away from a consumer-driven economy without deflationary pressures coming from household deleveraging, weakness in commercial real estate, and pressure on local/state governments and local/regional financial institutions. The panicky flight to high yield debt (junk bonds, muni debt) could end badly if we get a second bout of deflation.

* If I have to bet on the future, I'll bet on countries with favorable demographics, favorable balance sheets, favorable rates of taxation, and freer markets. Free markets are messy and far from perfect, but they are ultimately self-correcting; centralized ones are not.


TD said...

On your point about the debt burden, isn't inflating the debt away much more likely than transforming the US economy into an export-driven one? There are two ways to effectively default on your debt. The first is to stop paying interest (highly unlikely for the US). The second is to let inflation reduce the par value (in real terms) for you.

Brett Steenbarger, Ph.D. said...

Hi TD,

I think that transitioning to an export-driven economy by weakening the dollar and making US good cheaper *is* inflating away the debt.


Vic said...

Dr. Brett,

Not sure what your take on Canadian markets are but the Bank of Canada is about to raise interest rates in the next month or two and possibly a half point to start.

As well TD Bank is calling for 11 quarter point raises over the next 1.5 to 2 years. With a US style housing bubble in place I am not sure how this plays into how the US evaluates staying in step or close too it with the Loonie above par with the US dollar. Any thoughts ?

skipper said...

Thanks Doc for sharing your thoughts. I truly appreciate all your posts and have learned a lot from you. Cheers.

Ben said...

I have to disagree -- we are in unprecedented times, the markets will continue to rise and inflation will be huge. The US dollar will not decline but inflation will ravage the purchasing power many fold over the next 3 years

Mike said...

We will reach a point where we can no longer finance the growing debt. Then nobody will want to own treasuries. That will cause inflation with all of those excess dollars that are not wanted. Labor costs will fall as they won't keep pace with inflation here, and things that must be bought and sold here like real estate will probably fall also. Americans will see inflation of products they want to own like gas, cars, durable goods and food, and loss of value of assets they have tied up a lot of money in like their homes. Loss of value in the sense that those assets won't rise at the rate of inflation because nobody will be able to afford to buy at the inflated prices. Real estate will still hold up better than cash probably but it will take another beating.

I thought the Euro might fill in as a possible alternative to the dollar as a reserve currency but it appears that there is too much debt there as well.

We will reach a point where our labor is cheap enough (wages will be destroyed by inflation when they won't keep pace with it) on a relative scale to be competetive again and we start exporting again. To be competetive the standard of living of they typical middle class family here will have to be cut in half and it will happen. Welcome to the world of extended families, sharing cars, car pooling, home cooking, borrowing a cup of sugar from the neighbor, and keeping the house heated to 60 with sweaters.

Davide said...

Dr Brett,

thanks for sharing.

I tend to agree with Mike's comment, and have some reservations about who the US would be exporting to in this world, so far dominated by US consumption!

Otherwise, concerning the debt issue, the latest piece from GEAB / LEAP 2020 (subscription required) has some interesting points on it. Enough snippets to get the whole picture are available for free on their site.