Up with bonds, down with equities, out with with-profits

After the stockmarket ructions, pension funds are getting more cagey and thinking about weighting more towards bonds (htp: Pension Pulse). (A seminar I went to maybe 10 years ago predicted this trend.) Bill Gross of Pimco is also thinking that way; at the same moment when others reckon the recession's over, or nearly so.

My concern is that the market is now so volatile that only active traders will be interested. The smoothing approach of British with-profits funds has been undermined by downswings so sharp that more than once recently, they have had to apply penalties to investors seeking to exit early; which in turn will make those investors less inclined to reinvest in with-profits, and indeed quite possibly put them off investment generally.

That, plus the need to take more income as the population ages, plus a poorer next generation that will work longer, be taxed more and have less in State and other pension provision, plus the burgeoning of the world population, the gradual equalization of world average income (and it's a very low average), plus increasing ecological limits to fast-buck-type growth, all tend to make me more a bear than a bull for as far as I can see, whatever may happen in the short term as a result of desperate overstimulation with fiat cash.

Yes, there'll be opportunities for the agile financial player; but for the mom-and-pop saver?

"Get out of the market" - RBS strategist

A caller to the excitable Max Keiser's show (htp: Nathan Martin) quotes from a statement by Bob Janjuah at Royal Bank of Scotland, warning clients to cash in and hunker down while the market tests "new lows". (And Jesse says "wealthy insiders are increasingly trying to liquidate investment positions to raise cash and diversify their holdings into cash and hard assets.")

Keiser got wide attention in July when he referred to Goldman Sachs as "scum" and (I think, not incorrectly) said that the practical results of some of their activities were worse than terrorist atrocities. Protests like this make no difference, except that they may relieve hearts clogged with helpless anger: what we've learned recently is that the shameless tenacity of politicians and bankers will outwear public indignation.

But society may change when everyone gives up looking to the the über-scum to help, and concentrates instead on personal benefit and survival. I think I may not even bother to vote in the next General Election.

Oh, and Nathan Martin also directs us to an article by Robert Kiyosaki, who compares the market to a dead frog galvanized by ever-higher charges of financial electricity until "Pretty soon the dead frog will be fried frog." Kiyosaki cites demographic change as a major threat in the long term.

Hi yo, Silver

Jesse surveys measures of monetary growth in the USA. He concludes that inflation is likely to drag the dollar down and shares upwards (N.B. in the 70s, they didn't rise as fast as inflation); as to commodities: "silver may be one of the first commodities to break out because the government maintains no significant physical inventory of it as it does for gold and oil."

UPDATE (re silver): Tim "Mess that Greeenspan Made" Iacono thinks so, too.

Defying gravity

"...the equity markets are simply not acting in a rational manner given the underlying issues in the economy and credit markets"

So it's not just my perception. Read Karl "hold cash" Denninger's latest.

Warren Buffett's misleading optimism

Jonathan Chevreau reports Warren Buffett's bullishness on the US economy, long-term; but the real gem in this piece is the extensive, but cogent and crunchy comment by Andrew Teasdale of The TAMRIS Consultancy, who analyses Buffett's real approach to equity valuations.

Teasdale points out that although interest rates hit 21% in 1982, there was less debt, higher disposable income and lower valuations: relative to disposable income, debt is a bigger burden today than it was 25 years ago. He summarises his position pithily:

It is also worthwhile remembering that not everyone holds a Buffet portfolio and not everyone has the luxury of a 220 year investment horizon. If I was a long term investor with no financial liabilities arising over the next 15 years equities would be my preferred asset class relative to cash and bonds, but I would be mindful of valuations in determining where I put my money.

Not all the bad debt has yet surfaced, and as Karl Denninger comments, even at this stage Citibank has recently been forced to borrow foreign money at 14%, and other banks at over 7%, in preference to the 3% Federal Funds rate, presumably to keep the scale of their insolvency in the dark.

Inflation is increasing, therefore money-lenders are going to want more income to compensate for risk and the erosion of the real value of their capital. For the yield to rise, the capital value of bonds has to fall.

So I read Teasdale's summary as implying that for now, it's cash rather than either bonds or equities.

Recession QED

In an educational (and mercifully profanity-free) essay, Karl Denninger builds up his case from first principles, explaining the processes of creating and destroying money. He expects house prices to fall back by 30 - 50% and notes that in a recession, equities typically lose 30%.

He says the media is not reporting the truth. I tend to agree: I now throw away the Sunday football and financial supplements at the same time. If you want to know what's really happening, he says, watch what is going on at the banks, the Federal Reserve and Goldman Sachs, all of whom are battening the hatches, while CNBS (also castigated by Jim Willie) plays a cheerful tune to the proles.

I've written before how in 1999, as a financial adviser, I sat through a presentation from a leading UK investment house about tech stocks, which were supposedly about to start a second and bigger boom. I suspected then, and even more so now, that they were looking for the fabled "bigger fool" to offload their more favoured clients' holdings. Denninger intimates the same:

Are these shows, newspapers, and others reporters on the financial markets, entertainers, or worse, puppets of those who know and who need someone – anyone – to unload their shares to before the markets take a huge plunge, lest they get stuck with them?

Then he gives his predictions - which are grim, but not apocalyptic. It's the fools who will get roasted, not everybody. (By the way, Denninger is another Kondratieff cycle follower.)

What to hold, in his opinion? Cash, definitely; anything else, check the soundness of the deposit-taker. If you want to gamble on hyperinflation, he thinks call options on the stockmarket index are likely to yield more than gains on gold, even if the gold bugs are right.

This is where I thought we were in 1999. Thanks to criminally reckless credit expansion in the interim, we're still there, only the results may be worse than I feared then.

Oh, and he thinks the dollar will recover to some extent, because the rest of the world is going to get it just as bad, and probably worse. (Interesting that the pound is now back under $2.)

Visions of 2008

Following Dearieme's comment on the previous post*, I'm going to try to visualise a chain of events over the next year - guesswork, of course, with plenty of obvious ones:

USA

a marked deflation in property prices
a reduced demand for luxury goods and services
reduced imports of the above
consequent recession abroad
further interest rate cuts
higher unemployment
higher taxes
higher State and Federal budget deficits
a sell-off in equities
increased demand for bonds
a weakening currency
higher prices for food, fuel and clothing

increase in the price of good-quality agricultural land
consumer price inflation indices will not be able to continue to mask the real increases in costs of living, and this will have further consequences for public finances
public enquiries, leading eventually to a thorough reform of the financial system

UK

much the same as above, except I don't think our house prices will fall so far - the US subprime mess will hit investments, but we will drop our interest rates to devalue the pound to maintain stability against the dollar

Gold

will continue to fluctuate interestingly, but although some smart money is after it, there will be less spare money around generally, and other commodities will offer interesting opportunities for inflation-beaters. It's already above its inflation-adjusted long-term trend, and lenders will make sure that the real value of their loans is not destroyed by hyperinflation

... in short, slumpflation.

UPDATE

*and, by way of comparison, here is Karl Denninger's outlook in his Dec 24 post.
... plus a more sanguine assessment by Nadeem Walayat.

A Merry Christmas to all, and thanks for your visits and comments.

Hussman's view: white water

John Hussman is an American fund manager and takes pains to show that his judgments are carefully weighed; so his warnings are unlikely to be Chicken Little squawks:

In July, he looked at historical "awful times to invest", and found that July 2007 fits the same criteria. The 10-year outlook for the US investor is not attractive:

Presently, the probable total return on the S&P 500 over the coming decade ranges between -4% and 5% annually, with the most likely outcome in the low single digits.

More recently (November 12), he's considered many indicators and concluded:

I expect that a U.S. economic recession is immediately ahead.

(highlights mine)

This week (November 19), he remarks that much of the money apparently being pumped into the economic system is simply a rollover of earlier loans coming to maturity: the net increase is very small compared to the total oustanding, and so the rate of monetary inflation is slowing. He quotes Jan Hatzius of Goldman Sachs as saying (in effect) that if souring subprime debt hits financial institutions directly, they are likely to call in loans in order to preserve the ratio between their lending and their reserves, which in turn will slow the economy further.

What should investors do? He quotes the view of famous investment manager Jack Bogle:

"I would say do nothing – ride it out, if your asset allocation is right. The bonds in your portfolio and the long-term growth of businesses will bail you out. Unfortunately 80% of the market is speculators now, not investors. What would I say to the speculator? I would say I'm nervous and I might even say get out.”

So I guess it's the usual couple of points: are you in for the long term, or trying to make a quick killing? And where are you on the 25:75 Benjamin Graham bond-equity balance?