As markets tumble we have to ask the same question we have asked ourselves so many times before. Is the economy, once again, heading into a deflationary de-leveraging spiral?
The 10yr T-bond rates would answer this question with a resounding answer – yes!
Lipper fund flow data has continued to roll in month after month as if a recession where in full motion. There has been next to no investor appetite for pro risk assets during this post 2008 ‘recovery’. Here the latest Lipper report pdf.
These negative fund flows as regards risk can also be seen in the consumer sentiment numbers that continue to be very weak.
The deflationists arguement that you cant push on a string is being repeated here. Consumers want to deleverage after a period of over consumption whereas their government is pushing them to re-leverage and take on risk. Although savings rates remain low in the US cash savings are being accumulated and staying as cash deposits.
The central bank monetizes debt and lowers interest rates to push capital holders out of cash and bonds lowering interest rates so that even a minimal positive return will be force risk takers to invest their capital. This is the theory but as we can see from the Lipper data capital holders continue to take year on year negative returns in preference to risk taking.
Yield decompression continues in the S&P as earnings breakout to record levels and price earnings ratios continue their march downward.
Here a report released yesterday to me from a highly respected research co on S&P 400, 500 earnings. Historic and forward charts.
Earnings have risen, as you can see, way beyond their 2008 highs. Many company’s balancesheets are much stronger now than they were in 2008 but many are worse as they continue to mop up toxic assets in the search for yield and in fullfilling central and local government’s nevr ending need for credit. Here the summary chart from the report.
This is strong stuff and given an accomdative central banks as well as proactive governments makes for a once in a decade investment opportunity especially given the consensus move out of equities into bonds and cash.
Indications at present are merely that some are seeing a continuation of this risk off world alongside higher inflation. We can deduce this from the TIPs (inflation adjusted bond chart). Here
“Timing is everything” as a famous comic once said. This is even more true in investing and trading. On this basis we can say the following paragraph with some certainty.
The developed world continues to see stressed balance sheets across her leveraged financial sectors. This is occurring as cash and bond deposits continue to grow but liabilities grow faster as governments continue to borrow at a faster rate than nominal inflation. Balance sheets are therefore worsening not improving. If this trend is not reversed very quickly another balance sheet solvency collapse will inevitably occur with the resulting severe deterioration in confidence and investment. Given unemployment levels, wages and public finances are close to their limits of democratic tolerance a collapse at this point may result in consequences that nobody in the system can anticipate. As the ratio of existing money on the slide lines (parked in cash and bonds) is so high the dilution effects of money printing will be low. In effect the inflation risks of ‘action’ by policy makers is at an extremely low point. The ‘game’ of money printing to encourage demand will end but not when the ratio of cash and bonds to new money required is so low. Only when this ratio gets completely out of step will the game truly be up.
The rational in this paragraph continues to motivate me towards blue chip, high yield stocks. The trade has become a contrarian trade and this is a good thing. It is not a crowded trade. The upside is significant. The data of other areas of the world where balance sheets became stressed and countries demanded money printing as a solution to their insolvency issues are instructive at this time, i would argue.
The downside is another complete collapse of the system. I therefore am limiting my leverage but allocating all possible cash and bond savings to yielding risk assets.
You pay your money to take your chance in life.
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