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Thursday, September 25, 2014

Should we be worried about global inflation?

There is a gross straw argument being perpetrated by economists and market pundits, and that is the prospects of 'rising' or run-away inflation, or at least the ominous threat of such. It is important to note two things:
1. Inflation is a monetary phenomenon
2. Inflation is a red herring
3. Commentators don't even know what inflation is

Consider the following article from Ben Eisen at The concern is that there is 'low fears of inflation'. The reason this is bad is purportedly because:
"Most economists believe some level of inflation is important to a healthy economy".
The problem with this perspective is that they think general price variance is a 'demand phenomenon' rather than a monetary phenomenon. The reason they think its not a 'monetary phenomenon' is because the Fed has launched a monetary stimulus program, and according to them, it disproved the Austrians who argued it would cause inflation. That might well be the argument of some or all Austrian economists, however I would counter that 'cost-of-living' inflation is not the only form of inflation. In an era of ultra-easy monetary conditions (i.e. low interest rates), money has fuelled a speculative bubble. It is easy to observe this in two respects:
1. The high prices for property in Western markets
2. The indebtedness associated with derivatives contracts has ballooned

The reason why we aren't seeing a lot of 'cost-of-living' inflation like in the 1970s and 1980s is simply because in those times there was no prospect of wage restraint. Unions were unfettered in their capacity to demand higher wages, so any rise in prices was destined to trigger a wages spiral. Today, there is no prospect of a wages spiral, not because unions have been busted, as that was merely the 'effect'. The reason is that unskilled workers in Western countries are in a very weak position to demand higher wages. Few industries are in a position to demand higher wages, and the reason is that:
1. Few industries (like mining, ports and government services) can get away with it without precipitating a shift in services offshore to emerging markets where labour is far cheaper.
2. There is no peer support from other unions for such rises. They are a collective organisation. You are not going to see 80% of union members supporting wage increases for 20% of members.

The flipside was that union membership has fallen instead because unions can no longer deliver on what members wanted - higher pay.

So what do we make of this logic?
"The U.S. central bank is targeting a 2% annual rise in consumer costs. The drop in market forecasts for inflation implies investors think the Fed will abandon that mandate and raise rates".
The reality is that the 'cost-of-living' inflation is destined to tread a path broadly inline with the rate of money supply increase. The reason is not because money supply is increasing, but because governments look to rising inflation to finance government. Governments don't want to be obliged to raise taxes. This was why it was so hard for the Japanese government to raise taxes. It would have been felt by the people. This is not a concern in other Western economies, where economic activity in rising, population is growing. Japan was unable to rely on these forms of stimulus because of its conservative people. The government was confronted with an unpopular choice - allow relaxed immigration, raise taxes or print money. It decided to print money and raise taxes. It scarcely delivered on the reform it promised.

You might wonder whether we need to be worried about rising interest rates. The answer is no. The Fed might well allow interest rates to rise, but they will never be allowed to rise more than enough to squash rampant speculation. The housing market is not overly priced. Current price levels are sustainable because there is simply no reason for raising rates, and current prices are actually reasons not to 'scare asset markets'.

Deflation is not actually bad; its just bad for government. Deflation is a natural inclination for markets because its a signal of rising purchasing power that is associated with wealth creation. It is not however conducive to governments raising revenue, so governments like some 'healthy inflation', or easily-won taxation. Governments don't like to have to qualify their actions because we have so little trust in them.

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Thursday, September 18, 2014

Global equity markets restore uptrend and positive outlook

My earlier concerns in anticipation of a Dow 'market correction' proved ill-founded. It turned out to be simply a 'consolidation phase' or channel trend, which has given away to the preservation of the existing trend. During this type I sat out of the market, and to good result. I exited IVR at 3.5c, buying back at 3.3c, in anticipation of some possible drilling results. The results are only half-way out, with 4500m of a 13,000m drilling program completed. The results have not been as good as I expected, prompting the stock to fall back 20% before recovering (-15%). These are the risks that one takes on explorers. I was looking for a 200% gain, but instead I have an 'ambiguous loss', whilst I wait for more results.

Looking at the Dow Jones, we can see that it has closed at a new intra-day and daily high of 17,266 points, so this augers well for the sustenance of this trend for the time being. The question is, when might we expect a correction. We can see from the following trend that the market is well-above its trend, and I would be reluctant to read too much into a daily data. We might yet see a 'cancelling' correction, however this 'break' into a new high, and the fact it closed at a high does auger well for sustainability of the trend.
 I have always said that there are two things which will break this market:
1. Asset 'bubbly' prices
2. Rising interest rates

Technical and psychological issues like a 2,000pt S&P, this chart trend, as well as the recent passing of Sept 11th were concerns. I don't see any substantive reason for raising interest rates, and if there are any such rises in interest rates by the Fed, it will be because of excessive demand in the economy, not because of concerns about spiralling wages. So it would only be constraint on a strong economy, and not a blood clot causing an economic hemorrhage.  For this reason, I'm expecting a rapid recovery from any sell-off 'correction phase'. That's not that we should not seize the opportunities to sell.

Another way of looking at the market is that, this might have been a good indicator for the government to look at raising interest rates. I'd caution against that, and say, it would be better for the government to look at 'real avenues' for stimulating economic activity beyond speculative demand in assets. The best ways of doing this are:
1. Privatisation
2. Market reform
3. Welfare reform
4. Political reform

There is every reason to expect more privatisation, and the TPPA might be construed as 'market liberalisation', but in fact its 'market management' by powerful friends of government. There has been some reform of welfare. There is evidence of a shift from 'unconditional' to 'conditional love'. Political reform is however a long way off. We might be encouraged by talk to secession in Scotland, independence in Myanmar, binding referenda in NZ, but these measures are mere 'smoke' in your screen.

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Wednesday, September 10, 2014

The prospects for a short term sell off in place - but how severe?

On the 27th August 2014 (2 weeks ago) I gave a warning of a possible correction in equity markets, based on the leading S&P500 Index. The prospect of a correction remains in play. Today, I'm outlining the technical drivers for a correction based on the Dow Jones Industrial Average - which is based on 28 of the leading stocks in the United States. This index is actually a better guide to the international market given the focus on the larger 'multinational' corporations.

Starting at the shortest-term chart, we can see that the index price action is trending down, and making successively low-lows, where previous support on the downside becomes resistance on the upside, conveying a downward market.
In the 2nd chart, the longer 2 month chart shows that we remain in a broader 'channel trend', so the market is ambivalent about direction, or otherwise stated, the market is an ongoing fight between buyers and sellers. You might also argue that large investors are buying or selling in this range, where buyers are actually placing large sell orders on to create resistance levels, so they can accumulate stock slowly below those resistance levels. Likewise, those companies with an adverse outlook, are placing large orders at support levels, and selling in anticipation of the channel structure breaking on the downside. The implication is that when the market finally 'breaks' it will either be a big move on the upside or downside.

The third chart is interesting because it conveys that the market is challenging previous resistance, and that its at previous highs. You might have heard as much in the last few weeks, and yet it remains at those 'highs', but sparingly so. The market has not marched on, but rather languished around those highs. In fact, it was sold off significantly to 16,500 points in late July. The index however preserves its uptrend. The question is whether it is going to break the long term trend. This is arguably just the same type of consolidation as occurred in Jan 2014, before the market marched on further.

Looking at the last chart, we can see that we are in the 5th year of this 'long market rally. Most market cycles are 7-8 years long, so it might be argued that this one has a little time to run. If this is your logic, than you might still want to exit the market because the market is still way off its long term support. It has the capacity to fall from the current 17,040 level to 16,500 points. There are a number of issues to precipitate that:
1. The poor job growth in the USA - real jobs I mean - not govt revision of methods that see 'self-starters' living on benefits classified as 'nascent entrepreneurs'. That's not to say that a "Bill Gates love child" is not among them, but rather that, you probably have not met the children of Bill Gates. But who you have undoubtedly encountered is the children of your typical conservative family, whether they are libertarians, anarcho-capitalists or liberals. They are less interested in making money until they desperately need a benefit.
2. The prospects of sustained war with Russia in the Ukraine - There is some apprehension about a protracted war. I personally don't see how such a war is likely given the capacity of Western nations to undermine the logistical support lives of counterparts. There will not be a war, but there will be a lot of bluffing. In the interim, you have a lot of apprehension, and war only undermines confidence.
3. The prospects of a terrorist threat. Today is Sept 11th. Are we going to expect a re-occurrence of terror? Its a symbolic gesture that undermines market confidence, however this time round the 'potential' is worse than the reality because it immediately becomes apparent that life goes on, and there are just too many targets. Whose going to miss a flight? The 300 passengers on board a plan and 15,000 relatives and 30,000 friends. Its very sad, but the world will go on. Even if you had 10 such events a year, it would be traumatic, but we would endure it. The odds of it happening to people in 'most parts of the world' are low. Most events would be in certain parts of Asia, EU, Africa and the Middle East. i.e. In places where markets are small or already depressed.

We are looking for a retracement to 16,500 points, and thereafter a possible fall to 14,000 points. The foundamentals for the global economy are actually very good. The problem I would argue is not the 'fundamentals' of excess debt, but really the travesty of too high property prices. The reason is that, when property prices get to a point where they are so high, two things happen:
1. Existing property investors see no further opportunity for gains, so they are not financing their activities with more passive property income
2. Aspiring property buyers are deferring their property purchases, which means they are not buying all the accessories that go with property acquisition.
3. Revision of market values are occurring as well. Many youths are responding to the 'new market reality' with more modest consumptive patterns of behaviour. This is great for the environment, for their long term 'savings sustainability', but it hits the current 'consumption driven' paradigm for this economy.

The implication is that once the stimulus from the central banks is seen for what it is, this market is going back down, and it will hurt the speculators and savings of people. This is part of the appeal for the government. Its your savings, so the impact is on your balance sheet, not the 'public budget'. The fact that you don't need to worry because your super will not be claimed for years, is part of the reason why, as investors, you will tolerate their bad custodianship, and not question the legitimacy of their form of governance. So we can expect government to continue going about their dirty business for at least the first start of this cycle, but in the long term there is solid prospects for political reform and fundamentally a very strong economy.

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Investment Strategy

If you are investing for the long term, you still need an investment strategy. Dont be fooled by the rhetoric of fund managers. The reason they advise you to 'buy & hold' is because they dont want to compete with you in sell-offs. Markets and industrial sectors are cyclical, so they demand trading to get the best returns. Fund managers actually cant hope to match the performance of small investors (if you are half good) because they have to manage huge amounts of funds and charge you a fee besides.
MY ADVICE is (i) look at a range of market indices and decide upon what level of correction would give you the justification you need to get in & out of the market. It might be a 5-10% retracement or a break of trend. (ii) Diversify if you dont have an intimate knowledge of the company or management. More than 30% in one company is aggressive.

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