The Economy and Bond Market Radar (August 6, 2012)

Sunday, August 5th, 2012

The Economy and Bond Market Radar (August 6, 2012)

Treasury yields were little changed this week as a tug of war continues between global central bankers and economic data. This week was all about the Fed and ECB announcements, which came in with a bang last week but went out with a whimper this week.  Neither central bank took action and, once again, tried to reassure the markets with words not action. Global economic data remains weak as can be seen in the JPM Global PMI chart below, which indicates a global contraction in manufacturing. Tempering this news was a better than expected employment report on Friday, potentially causing policy action indecision from the Fed.

Strengths

• July nonfarm payrolls grew 163,000 vs. the 100,000 that was expected and was the best showing since February.
• Retail sales posted surprising strength in July as same-store sales rose 4.4 percent.
• Consumer confidence unexpectedly bounced back in July, showing greater optimism about short-term business and employment prospects.

Weaknesses

• ISM’s July manufacturing index remained in contraction territory for the second month in a row.
• The Fed failed to take any action this week after it was widely viewed that the Fed planted those seeds in a widely disseminated story last week.
• The ECB also failed to follow through with any action and possibly lost some credibility with investors. The market has become used to a lot of talk from European officials but when the head of the Central Bank promises to do whatever it takes to save the euro and then is unable to articulate exactly what that entails, it raises credibility issues.

Opportunity

• The Fed and ECB are still talking about additional monetary stimulus and it may happen in the near future. Interest rates are likely to remain very low for the foreseeable future.

Threat

• Europe remains a wildcard with the markets shifting focus on a weekly basis.
• China also remains somewhat of a wildcard as the economy has slowed and officials appear in no hurry to take decisive action.

Tags: Bond Market, Consumer Confidence, Contraction, Credibility Issues, ECB, Economic Data, Employment Prospects, Employment Report, European Officials, Indecision, Market Radar, Nonfarm Payrolls, Shifting Focus, Stimulus, Term Business, Treasury Yields, Tug Of War, Whimper, Wildcard
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Bill Gross: Investment Outlook (February 28, 2012)

Tuesday, February 28th, 2012

​

(Defense)

• ​Over the past 30 years, an offensively minded Federal Reserve and their global counterparts were printing money, lowering yields and bringing forward a false sense of monetary wealth.
• Successful investing in a deleveraging, low interest rate environment will require defensive in addition to offensive skills.
• The PIMCO defensive strategy playbook: Recognize zero bound limits and systemic debt risk in global financial markets. Accept financial repression but avoid its impact when and where possible. Emphasize income we believe to be relatively reliable/safe; seek consistent alpha.

They say defense wins Super Bowls, but the Mannings, Bradys and Montanas of gridiron history are testaments to the opposite. Putting points on the board, especially in the last two minutes, has won more games than goal line stands ever have, even if the scoring has been done by the field goal kickers, the names of whom have been confined to the dustbins of football history as opposed to the Hall of Fame in Canton, Ohio. Canton, however, has an approximately equal number of defensive in addition to offensively positioned inductees, so there must be a universally acknowledged role for both sides of the scrimmage line. What fan can forget Mean Joe Greene, Deion Sanders or Mike Ditka? The old, now politically incorrect showtune laments that “you gotta be a football hero, to fall in love with a beautiful girl,” but football and any of life’s heroes can play on either side of the line, it seems.

My point about pigskin offense and defense is the perfect metaphor for the world of investing as well. Offensively minded risk takers in the markets have historically been the ones who have dominated the headlines and won the hearts of that beautiful gal (or handsome guy). Aside from the rare examples of Steve Jobs and Bill Gates, however, the secret to getting rich since the early 1980s has been to borrow someone else’s money, throw some Hail Mary passes and spike the ball in the end zone as if you had some particular genius that deserved monetary rewards 2¹⁰ times more than a Doctor, Lawyer or an Indian Chief. Nah, I take that back about the Indian Chief. The Chiefs, at least, have done pretty well with casinos these past few decades.

Still, the primary way to coin money over the past 30 years has been to use money to make money. Although the price of it started in 1981 at a rather exorbitantly high yield of 15% for long-term Treasuries, 20% for the prime, and real interest rates at an almost unbelievable 7-8%, the gradual decline of yields over the past three decades has allowed P/E ratios, real estate prices and bond fund NAVs to expand on a seemingly endless virtuous timeline. Books such as “Stocks for the Long Run” or articles such as “Dow 36,000” captured the public’s imagination much like a Montana to Jerry Rice pass that always seemed to clinch a 49ers victory. Yet an instant replay of these past few decades would have shown that accelerating asset prices weren’t due to any particular wisdom on the part of academia or the investment community but an offensively minded Federal Reserve and their global counterparts who were printing money, lowering yields and bringing forward a false sense of monetary wealth that was dependent on perpetual motion. “Rinse, lather, repeat – Rinse, lather, repeat” was in effect the singular mantra of central bankers ever since the departure of Paul Volcker, but there was no sense that the shampoo bottle filled with money would ever run dry. Well, it has. Interest rates have a mathematical bottom and when they get there, the washing of the financial market’s hair produces a lot less lather when it’s wet, and a lot less body after the blow dry. At the zero bound, not only are yields rendered impotent to elevate P/E ratios and lower real estate cap rates, but they begin to poison the financial well. Low yields, instead of fostering capital gains for investors via the magic of present value discounting and lower credit spreads, begin to reduce household incomes, lower corporate profit margins and wreak havoc on historical business models connected to banking, money market funds and the pension industry. The offensively oriented investment world that we have grown so used to over the past three decades is being stonewalled by a zero bound goal line stand. Investment defense is coming of age.

This transition is not commonly observed, although it is relatively easy to prove statistically and even commonsensically. Take for instance the rather quizzical notion that lower yields must produce an equal number of winners and losers since there is a borrower for every lender and the net/net therefore should have no effect on the real economy or its financial markets. Chart 1 shows that since 1981, which marks the beginning of the secular decline of interest rates, personal interest income has rather gradually (and now somewhat suddenly) shrunk relative to household debt service payments.

It is Main Street that has failed to keep up with Wall Street and corporate America in the race to see who can benefit more from lower yields. As the interest component of personal income gradually weakens, the ability of the consumer to keep up its frenetic spending is reduced. Metaphorically, it’s akin to a 4th quarter two minute Super Bowl drill, but one where the receivers haven’t been properly hydrated. They’re a half step slow, their legs are cramping, and it shows. Lower interest rates are having a negative impact on households because their water bottles are filled with 50 basis point CDs instead of Gatorade.

While Wall Street and levered investors have fared better than their Main Street counterparts, it’s not as if they’re in “primetime Deion Sanders” shape either. Conceptualize the historical business model of any financially-oriented firm for the past 30 years and you will see what I mean. Insurance companies, for instance, whether they be life insurance with their long-term liabilities, or property/casualty insurance with more immediate potential payouts, have modeled their long-term profitability on the assumption of standard long-term real returns on investment. AFLAC, GEICO, Prudential or the Met – take your pick – have hired, staffed, advertised, priced and expensed based upon the assumption of using their cash flows to earn a positive real return on their investment. When those returns fall from 7% positive to an approximate 1% negative, then assumptions – and practical realities – begin to change. If these firms can’t cover inflation with historical real returns from their float, then they begin to downsize in order to stay profitable. The downsizing is just another way of describing a transition from offense to defense in a zero bound nominal interest rate world where almost any level of inflation produces negative real yields on investment.
Not only insurance companies but banks suffer from this inability to maintain margins at the zero bound. In the process, they close retail branches that once were assumed to be the golden key to successful banking. Defense! And here’s one of the more interesting anecdotal observations on our current zero-based environment, one to which my investment paragon – Warren Buffett – would probably immediately admit. His business model – and that of Berkshire Hathaway – has long benefitted from what he has described as “free float.” Those annual policy payments, whether for hurricane, life or automobile insurance, have long given him a competitive funding advantage over other business models that couldn’t borrow for “free.” Today, however, almost any large business or wealthy individual can borrow or lever up with minimal interest expense. Buffett’s “Omaha/West Coast” offense is being duplicated around the world thanks to central bank monetary policies, placing an increasing emphasis on stock and investment selection as opposed to business model liability funding. Buffett will succeed based upon his continued strong offensive play calling, but the rules of the game are changing.

The plight of Buffett of course is in some respects the plight of PIMCO or any investment/financially-oriented firm in this new age of the zero bound. And it seems to us at PIMCO that successful investing in a deleveraging, low interest rate environment will require defensive in addition to offensive skills. What does that mean? Well, let’s briefly describe PIMCO’s own historical investment offense for the past 30 years in order to provide a defensive contrast:

PIMCO Offensive Strategy 1981 – 2011
Ready, Set, Hut 1, Hut 2 –

1. Recognize downward trend in interest rates and scale duration accordingly.

   A. Emphasize income and capital gains. PIMCO Total Return Strategy.
   B. Utilize prudent derivative structures that benefit from systemic leveraging – financial futures,
   swaps (but no subprimes!)
   C. Combine A and B along with careful bottom-up security selection to seek consistent alpha.

PIMCO Defensive Strategy 2012 – ?
Ready, Set, Hut, Hut, Hut –

1. Recognize zero bound limits and systemic debt risk in global financial markets. Accept financial repression but avoid its impact when and where possible.
   
   A. Emphasize income we believe to be relatively reliable/safe.
   B. De-emphasize derivative structures that are fully valued and potentially volatile.
   C. Combine A and B along with security selection to seek consistent alpha with admittedly lower nominal returns than historical industry examples.

So there you have it – the PIMCO playbook. I suppose if I had any common sense I would hold up that clipboard to the front of my mouth like sideline coaches do during big games. Don’t want to chance any of the competition reading our lips to get a heads up on PIMCO’s next offensive play call. But then that’s never been my or Mohamed’s style, given the importance of informing you, our clients, of what we are thinking when it comes to investing your hard-earned capital. Go ahead competitors and read our lips, we’ll just pound that pigskin down the field anyway. Besides, as I’ve pointed out, the emphasis these days should be on the defensive coach. Leveraging has turned into deleveraging. 15% yields have turned into 0% money. The Super Bowls of the future will have their Mannings and Bradys, but the defensive line may record more sacks and make more headlines than ever before.

William H. Gross
Managing Director

Tags: Bill Gross, Bradys, Debt Risk, Defensive Strategy, Deion Sanders, Derivative Structures, Downward Trend, Dustbins, Field Goal Kickers, Financial Repression, Football Hero, Global Financial Markets, Gross Investment, Hail Mary, Handsome Guy, Interest Rate Environment, Investment Outlook, Joe Greene, Lamentation, Mike Ditka, Monetary Wealth, Offensive Skills, Offensive Strategy, Pigskin, Printing Money, Rare Examples, Ready Set, Risk Takers, Ron Paul, Scrimmage Line, Superpac, Whimper, Zirp
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Fed Ends 2011 with a Whimper (Sonders)

Wednesday, December 14th, 2011

Fed Ends 2011 with a Whimper

December 13, 2011

by Liz Ann Sonders, Senior Vice President, Chief Investment Strategist, Charles Schwab & Co., Inc.

Key Points

• There were no surprises out of the Fed meeting today, with short-term interest rates remaining pegged at zero.
• There was one dissenting FOMC member who wished for additional policy accommodation.
• Much of the Fed’s near-term focus remains on the eurozone debt crisis.

The Federal Open Market Committee (FOMC) held its final meeting of 2011 and went out with a bit of a whimper. There were very few changes in its statement relative to November’s, although it did mildly upgrade its assessment of the economy: “The economy has been expanding moderately, notwithstanding some apparent slowing in global growth.” The Fed also gave a nod to recent improvement in jobs: “While indicators point to some improvement in overall labor market conditions, the unemployment rate remains elevated.”

However, the Fed did downgrade its assessment of the investment climate: “Household spending has continued to advance, but business fixed investment appears to be increasing less rapidly and the housing sector remains depressed.” This last comment about housing was a touch perplexing given what it didn’t contain: any nod to the fact that in the past month there have been strong readings for mortgage applications, easier mortgage lending conditions and a surge in homebuilder sentiment.

There was one dissenter—Chicago Fed Bank President Charles Evans—who wanted further easing. This was his second consecutive dissent, supporting “additional policy accommodation,” according to the statement. “There’s simply too much at stake for us to be excessively complacent while the economy is in such dire shape,” Evans said in a speech last week in Indiana.

No QE3, but Operation Twist affirmed

Surprising to us has been the fact that there’s been some chatter about the Fed considering a third round of quantitative easing (QE3). We’ve felt since the Fed’s announcement of “Operation Twist” in September, it was unlikely to follow up so soon with QE3. The Fed has basically said the risks were too high and it was disinclined to expand its balance sheet any further.

The Fed did note it would continue its exchange of $400 billion of short-term debt with longer-term securities to lengthen the average maturity of its holdings, the move referred to as Operation Twist, which doesn’t expand the Fed’s balance sheet. And of course, the economy has improved markedly since September, with the unemployment rate down to 8.6%.

Across the pond

But the US economy isn’t all that’s on the minds of Fed policymakers. They’ve sounded increased warnings about the eurozone debt crisis, and in today’s statement noted: “Strains in global financial markets continue to pose significant downside risks to the economy outlook.” On November 30, the Fed led six global central banks and announced a 0.5% cut in the cost of emergency dollar funding for banks, with the money coming from the Fed’s currency swap lines. Over the subsequent week, the European Central Bank’s three-month dollar lending through the swap lines jumped to nearly $51 billion, up from $400 billion before the announcement.

New communications strategy coming?

There’d been some pre-meeting speculation that the Fed would begin to outline a new communications strategy, having noted in the minutes following the Fed’s November 2 meeting that “such accommodation would likely be more effective if it were provided in the context of a future communications initiative.” We didn’t get any details out of today’s meeting, and that may be a function of its one-day length, versus the longer two-day meetings during which meatier topics are typically discussed. We’ll be looking for more detail about that in late January (2012′s first FOMC meeting takes place January 24 and 25), if not before then.

What would be the purpose of a revamped communications strategy? Fed Chairman Ben Bernanke has consistently stressed, “…for central banks with policy rates near the zero lower bound, influencing the public’s expectations about future policy actions became a critical tool.” In other words, when rates are already pegged at zero, one of the few tools left is words. More to come on that as we approach the Fed’s next meeting.

Important Disclosures

The information provided here is for general informational purposes only and should not be considered an individualized recommendation or personalized investment advice. The investment strategies mentioned here may not be suitable for everyone. Each investor needs to review an investment strategy for his or her own particular situation before making any investment decision.All expressions of opinion are subject to change without notice in reaction to shifting market conditions. Data contained herein from third party providers is obtained from what are considered reliable sources. However, its accuracy, completeness or reliability cannot be guaranteed.Examples provided are for illustrative purposes only and not intended to be reflective of results you can expect to achieve.

Tags: Bank President, Charles Evans, Charles Schwab, Chicago Fed, Chief Investment Strategist, Debt Crisis, Fed Meeting, Federal Open Market Committee, Household Spending, Indicators Point, Investment Climate, Liz Ann, Mortgage Applications, Mortgage Lending, Open Market Committee, President Charles, Qe3, Senior Vice President, Term Focus, Unemployment Rate, Whimper
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The US is Now a Corporate Monarchy (Barry Ritholtz)

Thursday, November 17th, 2011

This morning, the eloquent Barry Ritholtz (the godfather of financial blogging) has published an excellent post re: his thoughts on how America has been hijacked by a “Corporatocracy,” and wonders why we seem so sedate, and not outraged; A highly thought provoking must-read!

by Barry Ritholtz, The Big Picture

I did an interview with a print reporter yesterday about what has been going on with lack of prosecutions, the banks, and Wall Street in general. We discussed the corrupt exchanges and HFT.

Tags: Barry Ritholtz The Big Picture, Bombs, Branches Of Government, Corporatocracy, Cowards, Crooks, Democracy, Ebay, Europeans, Futures, Godfather, Legislative Branch, Monarch, Monarchy, Print Reporter, Prosecutions, Sadness, Son Of A Bitch, Wall Street, Whimper
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Japan’s Demographic Time Bomb Set to Go Off; World’s Largest Pension Fund May Have to Sell Japanese Bonds

Friday, February 25th, 2011

by Michael ‘Mish’ Shedlock, Global Economic Trends Analysis

It’s now official. Japan’s demographic time bomb has gone off. However, don’t look for a big crater, at least just yet, because this has started off with a whimper and not a bang.

Inquiring minds note the World’s Biggest Pension Fund May Sell Japan Bonds.

Japan’s public pension fund, the world’s largest, said it may become a net seller of bonds to cover payments in the world’s most rapidly aging society.

The Government Pension Investment Fund, which oversees 117.6 trillion yen ($1.4 trillion), in September forecast that it would sell 4 trillion yen in assets in the business year ending March 31 to fund payouts. Sales may be less than that in the year starting April as bonds reach maturity, said Takahiro Mitani, president of the fund, known as GPIF.

“We will likely be a net seller in the market,” Mitani, a former executive director at the Bank of Japan, said in an interview in Tokyo yesterday. “We certainly have to come up with an adequate amount” to pay pensions, he said, declining to elaborate on the amount.

Sales by the fund, which helps oversee public pension funds for Japan’s 37 million retirees, come as the first of Japan’s baby boomers is set to turn 65 in 2012, making them eligible for pension payments.

The GPIF, historically one of the biggest buyers of Japanese debt, held 82.4 trillion yen in domestic bonds, or 70 percent of its assets, as of September, according to the fund’s latest quarterly financial statement. That compares with 12.6 trillion yen in Japanese stocks, or 10.7 percent, 9.6 trillion yen, or 8.2 percent, in foreign bonds and 11.5 trillion yen, or 9.7 percent, in overseas stocks, the report shows.

GPIF doesn’t plan to start investing in so-called alternative assets such as commodities, real estate, infrastructure, private equity or hedge funds because the risks don’t suit its strategy, Mitani said.
‘Too Early’

“It’s too early to get into alternative investments now,” Mitani said. “Japanese investors are conservative and it’s hard to justify to the public investing in asset classes such as commodities, real estate and hedge funds.”

Japan’s 10-year bond yield is the lowest in the world, data compiled by Bloomberg show. Japan’s gross domestic product shrank an annualized 1.1 percent in the three months ended Dec. 31, the Cabinet Office said on Feb. 14, and China’s economy overtook Japan’s as the world’s second largest for 2010.

People aged 65 or older will account for 29 percent of the country’s population in 2020 and almost 40 percent in 2050, according to the statistics bureau. They accounted for 23 percent population at the end of 2010, the highest among the Group of Seven countries, data compiled by Bloomberg show. That compares with 12 percent in 1990.

Japanese pension funds posted the lowest annualized growth among 12 countries between 2004 and 2009, at 2 percent in U.S. dollar terms and unchanged in yen terms, according to the survey. Brazil reported the highest growth, 24 percent in dollars, the report showed.

Thoughts and Implications

There is not going to be a huge exodus of Japanese bonds anytime soon. However, the world’s largest fund has gone from being a buyer of bonds to a seller of bonds. The amount is not trivial.

82.4 trillion yen in domestic bonds is about 1 trillion in US dollars. That is a lot of pent-up supply, especially when the government is running an annual deficit of of about $240 billion with no external buyers at all.

Those factors put huge pressures long-term upward pressures on interest rates.

Deflation Irony

The irony in this madness is that all the Japanese people want is their money back. They are not looking for appreciation. They do not have absurd pension plan assumptions like the 8% expected returns we see in the US. They do not want stocks, or real estate. They just want cash, and they want it to be worth something.

Yet, the Japanese government was hell-bent for two decades attempting to generate inflation which would have weakened the value of those bonds.

Recently, those bond holdings have been rising with a strengthening yen. However, lingering debt from preposterous deflation fighting efforts of building bridges to nowhere must be paid back.

Horns of a Dilemma

Japan choices are to default on its debt, print money to fund interest on the debt, raise taxes effectively robbing savers of their money, or undertake huge spending cuts.

The dilemma stems from years of Keynesian and Monetarist stupidity.

Japan Plans Tax Hikes

The Wall Street Journal reports Japan Issues Budget Deficit Plan

Japan’s government pledged to balance the nation’s main budget over the coming decade under its first fiscal-overhaul plan, approved Tuesday, laying the groundwork for the daunting task of tackling the country’s massive debt.

Highlighting the challenge of such an undertaking, the government estimated that if growth remains modest, it may have to fill an annual budgetary gap of about 22 trillion Japanese yen (US$242 billion) by the fiscal year ending March 2021. If Tokyo were to raise that amount only by increasing the 5% consumption tax—one gauge being used—it would need to increase the tax nearly threefold.

Prime Minister Naoto Kan’s government will kick off the fiscal-reform campaign by capping annual spending for the next three fiscal years and keeping new government bond issuance below 44.3 trillion yen next fiscal year. The debt amount is estimated the same as in the current fiscal year that started in April. Tokyo also promised to make “utmost efforts” to lower the amount in the following years.

The budgetary blueprints represent the first fiscal-reform plans adopted by the Democratic Party of Japan since it swept to power about nine months ago. They offer the clearest picture yet of how Mr. Kan’s economic team intends to lower the nation’s public-debt level, which at nearly twice Japan’s yearly economic output is the worst among advanced economies.

Japanese government bonds rose as investors welcomed the plan. Lead September JGB futures finished the day up 0.34 at 140.82, while the 10-year JGB yield fell to 1.185%, its lowest level since January 2009.

But questions linger about feasibility of the framework. Absent from the blueprint are detailed spending-cut plans, such as how much to scale back individual budget categories like defense and education. There also aren’t timetables for specific tax increases despite Mr. Kan’s calls for doubling Japan’s consumption tax in the coming years.

“The government has yet to provide details of how it can achieve the goal,” said Masashi Shimominami, a bond-market analyst at Mizuho Securities. Some investors also remain skeptical over whether Mr. Kan will rally enough political support for heavier taxes on consumption, Mr. Shimominami said.

The release of the plan comes as Japanese officials shift their policy focus to fixing budgetary woes after receiving a wake-up call from Europe’s deepening debt crisis. “We must make sure we avoid a situation where we lose trust in the government bond markets just like Greece and, as a result, interest rates rise sharply, putting our finances in a state of default,” the guidelines said.

No Political Will For Budget Cuts

As in the US, there is no political will for budget cuts. The best the government could come up with was a plan to freeze spending for 3-years. Whoop-to-do. Bear in mind that an aging demographic will require more health care.

Will growth be sufficient to make a long-term dent in Japan’s debt? I scoff at the notion. Moreover, rising energy prices will take a big bite of of Japan’s trade surplus.

By the way, in case you missed it, Japan’s trade surplus went negative last month. Supposedly it’s a one-time thing.

Japan posts first trade deficit in almost two years

Please consider Japan posts first trade deficit in almost two years

Weaker exports to key markets gave Japan its first trade deficit in 22 months, Ministry of Finance data has shown.

The trade deficit was 471.42bn yen ($5.7bn; £3.52bn) in January, with exports up 1.4%. Analysts had expected export growth to be closer to 7%.

Japan has struggled to boost exports as a stronger yen dents demand.

It recently lost its position as the world’s second-largest economy to China.
Changing scenario?

However, analysts said they expect exports to rebound.

That should help drive economic growth in Japan, albeit at a pace that is slower than many experts may have predicted.

One of the main reasons for the slower growth was weaker demand from China, where the government is battling inflation and signs that its economy may be overheating.

Japan is counting on increased sales to China when China is clearly overheating and will have to cut back. How do you think that fantasy is going to work out?

So, it’s back to tax hikes. To do it all with tax hikes, Japan would need to hike the VAT by 200%, from 5% to 15%. Is that going to fly with the voters?

Nonetheless, let’s assume Japan does hike taxes. Those tax hikes would strengthen the yen, which in turn would hurt Japan’s export growth and corporate profits.

My suspicion is Japan will print money, cheapening the yen, as the most convenient way out. Printing money will make matters worse in the long haul of course, but it will put off making any tough choices now.

Mike “Mish” Shedlock
http://globaleconomicanalysis.blogspot.com

Tags: Aging Society, Alternative Assets, Baby Boomers, Bank Of Japan, Brazil, China, Commodities, Demographic Time Bomb, Domestic Bonds, energy, Global Economic Trends, Government Pension, Hedge Funds, Infrastructure, Inquiring Minds, Investment Fund, Japanese Stocks, Michael Mish, Mish Shedlock, Pension Investment, Pension Payments, Public Pension Fund, Public Pension Funds, Stra, Whimper, Year Ending March
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If PIIGS Could Fly

Tuesday, February 2nd, 2010

This article is a guest posting from Niels Jensen*, Absolute Return Partners.

“A democracy is always temporary in nature; it simply cannot exist as a permanent form of government. A democracy will continue to exist up until the time that voters discover that they can vote themselves generous gifts from the public treasury. From that moment on, the majority always votes for the candidates who promise the most benefits from the public treasury, with the result that every democracy will finally collapse due to loose fiscal policy…”

Alexander Fraser Tytler, Scottish lawyer and writer, 1770

It was always naïve to believe that a crisis so deep and profound was going to go away with a whimper; however, an increase of more than 50% in global equity prices can be very seductive, and nine months of virtually uninterrupted gains have led many to believe that the problems of 20 08-09 are now largely behind us.

Well, not quite everybody. Friend and business partner John Mauldin remains a sceptic. I have had the pleasure of travelling across Europe with John over the past week or so and, as the week progressed, my mood swung decisively towards a state where Prozac would probably be the most appropriate remedy.

Now, John and I do not agree on absolutely everything. For example, I believe – and have believed for a while – that he is too bearish on equities. But, before we go there, allow me to share with you the essence of John’s views which can be summed up quite nicely by two charts, courtesy of BCA Research.

Chart 1: De-leveraging has a long way to go in the US

Source: BCA Research

In John’s opinion – and I do not disagree – we are still only in the second or third innings of the de-leveraging process (chart 1). Years of excessive debt accumulation cannot be reversed in 18 months, and it will take at least another 5-6 years to play out, possibly longer.

Chart 2: US Government borrowing has replaced private borrowing

Source: BCA Research

The other part of John’s argument – and again it is hard to disagree – is that it remains an open question how much de-leveraging has in fact taken place. As you can see from chart 2, US sovereign debt has…

Read the complete article here.

*Niels C. Jensen is a founding partner at London, England-based Absolute Return Partners. For more information visit, www.arpllp.com.

Tags: 6 Years, Absolute Return, Alexander Fraser Tytler, Business Partner, Democracy, Excessive Debt Accumulation, Form Of Government, Generous Gifts, Global Equity, John Mauldin, Loose Fiscal Policy, Niels Jensen, Nine Months, Partner John, Prozac, Public Treasury, Remedy, Sceptic, Scottish Lawyer, Whimper
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