Hitting A Wall By Mid-2010

July 30, 2009

The
U.S. economy could face tough times by this time next year. The intersection between politics and business is going to be a key.

 

Our pages have documented our world’s war and our nation’s battle with consumption and asset deflations/inflations. We have cited the July 1997 date as the divining rod of history when we tilted ever so slightly toward deflationary outcomes, which is still the case for our globe. Our financial system nearly melted down in 1997-1998 due to an emerging market credit-currency crisis. Competitive currency devaluations and global monetary accommodations saved our system, but it also made the globe highly dependent on selling goods to a leveraged
U.S.
consumer.

The Debt Devil saved us. We are his slave. He blows and bursts our bubbles. Since 1997, our reality has been beyond recognition. The highly touted economic moderation applauded by Wall Street and central bankers was nothing more than a credit bubble that inflated asset prices. Easy money also accelerated the rates of change of the price of stuff such as commodities, things consumed, things produced and securities traded. Yet corporate profits and equity earnings have gone nowhere since September 1997.

Going forward, household debt reduction, more balanced global consumption and production will designate the best/worst opportunities. It is also important to identify sustainable price trends from those divorced from fundamentals (bubbles). Laments such as “I did not want to be left behind my peers (the devil made me do it)” and “no one can identify bubbles” are excuses for improper risk/reward allocation.

The June 2009 InPerspective introduced our Price Index Score (PIS), which records this activity as a tradable harbinger of greed and fear. Figure 1 compares PIS to
U.S. inflation (CPI) and commodity price trends. PIS is central to our investment process. It helps guide our risk/reward allocation.


 

More precisely, we position assets to survive anxieties bred from the high volatilities of stuff and to account for Betas on the Cusp, which are assets that display directional equity beta during a credit crisis but normally do not. Consumer/producer index price uncertainties beget investor fear about future profits. In secular bear markets, fear dominates as asset classes discount extreme outcomes.

The Ebbing & Waning Of Deflation Fears

Lurking behind our ebbing and waning of deflation fears lies a deep-seeded knowing that we are short incomes and long many debts. The climate since 1997 has been very conducive to hedged portfolios via selling securities or reducing asset exposures with a price path dependency on credit formation and equity prices.

The Arrow Insights, LLC 75/50 Portfolio is long/short extreme scenarios and more normal outcomes through exchange-traded funds (ETFs). Our current allocation tilts toward an inflationary outcome. Most notably, we are overweight gold and gold stocks, which did well in the 1930s (a deflationary bust) and during the 1970s (an inflationary bust). The rest of our core holdings are better at hedging inflation.

First and foremost, we are inflationist in that we believe currency debasement is the likely outcome in political economies that overrule free markets. Yet we do not fear deflation. We are emboldened by our Reflexive Asset Allocation process, which balances portfolio assets to profit from inflationary/deflationary frequencies measured since 1920. We defend and advance portfolios in booms and busts.

 

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