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Friday, December 19, 2008

At some point, inflation

Sometimes it's useful to look beyond the current headlines to what may be coming over the next 3 to 5 years.

From my vantage point, what I see coming is inflation.

Currently, the news is filled with signs of deflation. Asset prices are collapsing. Housing prices are down significantly. Almost anything, other than U.S. Treasury securities, seems to be down over the last year.

Commodities have been particularly hard hit. It wasn't that long ago that oil was at $147 per barrel and people were talking about it going over $200. Now, it's below $40.

But, what has changed? Mostly, demand has dropped dramatically. As Economics 101 will tell you, when the demand curve shifts down and the supply curve stays the same, you get lower prices. I think I can safely say that has happened.

So, why had demand been crushed. In a word, deleveraging. The economy as a whole--businesses and consumers, at least--have been paying back debts to keep from going bankrupt. Not everyone is succeeding.

This reduction in debt has led to a tremendous fall-off in demand for goods and services of all sorts. You can see that clearly in the GDP and employment numbers. For those those who thought only Wall Street was in trouble, take another look.

But, the biggest debtor out there--the U.S. government--has been borrowing and printing money like it's going out of style.

Eventually, such borrowing and printing will get credit markets going. And, when they do, we'll all owe a lot more debt and have a lot more dollars chasing the same number of goods. In other words, inflation.

I don't think it will happen soon. Although the Fed is printing money and Congress is finding all kinds of ways to spend it, economic activity has slowed down so much that all it's doing is making deflation happen less quickly. Eventually, and over the next several years, economic activity will pick back up again and this will be visible in the so-called velocity of money.

When that happens, the demand curve will shift back up and prices will recover. But--and there's always a but--the government will be in a lot more debt and there will be a lot more dollars chasing the same amount of demand.

In 3 to 5 years, and perhaps sooner, the news won't be about deflation, but inflation. And, that inflation will be a lot higher than in the 80's, 90's or 00's. In fact, it wouldn't surprise me to see $300 a barrel oil and double digit inflation rates (not the core rate, but including food and energy).

With that in mind, you may want to consider inflation-proofing your portfolio over the coming years. Think about companies that can jack up their prices and customers will still pay. Think about commodity producing companies. Be wary of bonds with low payouts or higher risk of default.

It may not happen right away, but over the next several years, get prepared for inflation.

Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.

Friday, December 12, 2008

Keeping your head in trying times

The hardest part of watching the stock market recently has been keeping things in the right context.

The stock market is not a crystal ball that reveals a company's true worth. It merely shows what people are willing to buy and sell partial ownership of companies at any point in time.

But who is buying and who is selling?

Are sellers under pressure because they bought with borrowed money? Are they professional investors who are selling because their customers are cashing out in a panic?

Are buyers carefully considering the value of companies? Are they waiting to see what the government or other buyers and sellers will do next?

Markets do not reveal underlying worth, they simply reveal what people are willing to pay at a point in time. But, those assessments change over time--sometimes dramatically.

The way I'm keeping my head in these difficult times is to look past stock prices at the underlying businesses I own. Such businesses are in good shape and have bright futures.

Focusing on the underlying business is key to keeping your head. It allows the market to be your servant instead of your master.

Right now, and for some time to come I think, that servant will provide wonderful bargains on great companies.

As long as you look past the price at the underlying business, you too can keep your head and benefit from trying times.

Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.

Friday, December 05, 2008

Things are looking up

I'm not a market timer, but when market sentiment is as negative as it is now, it's not a bad idea to look for the silver lining which may mean things are improving.

Today, new unemployment claims came in at over 500,000, the worst report since the brutal 1974 recession. After these figures are fully adjusted over the next several years, it would not surprise me to see this number close to 1,000,000.

How is that good news? Because the market is up today!

When extremely negative numbers come out about the economy and the stock market doesn't go down by much or even goes up, it means people have fully grasped how negative things are and are starting to look for a future recovery.

That doesn't mean the market has bottomed or that all the bad news has been announced. But, it does mean that market participants are recognizing how bad things are and are perhaps seeing that things won't be so bad in the future.

Added to this, employment figures are a lagging indicator. That means that employment figures tend to look worst near stock market bottoms. Employment is a reaction to economic conditions, not a forecaster of them. Employment figures look bad when employers are throwing in the towel and laying people off. This is usually when the stock market begins to recover.

Why? Because the stock market is a forecasting mechanism. The price of a stock should be equal to all future cash flows. Prices shouldn't reflect current conditions, or even conditions over the near term, but should reflect all future possibilities of a company.

That's why the stock market tends to recover long before the economy, and why waiting for economic figures to improve is a sure fire way to miss out on huge market rallies.

I don't know if the stock market will go up next week, month or year, but I do know that many companies are trading at depression levels even though they have bright futures.

In other words, the best bargains in 25 years can be found right now, if you can see the silver lining.

Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.