I don’t run from the Bear Case, I embrace it, reading as much as possible from the pessimists while keeping my own emotions on an even keel and bearing in mind how infrequently the worst case scenario actually manifests itself.
The new bear case is the big D, as in Deflation, and every doomer I know or read fervently believes that the D is coming. They crave it, as it’s the only thing that will bail them out from almost seven years of water boarding.
I provide some links to better understand the D story below. Take with a shovelful of salt.
First up, Albert Edwards of Societe Generale is among the globe’s biggest money-losing market theoreticians this decade. He’s a really smart guy but thank god he doesn’t actually run any money. Had you invested based on his rhetoric, you’d have needed a dedicated phone line just for the margin clerks.
Here’s what he told a conference in London last week:
* 2015 is the year that “deflation will overwhelm the west.”
* “This is the year the markets really panic about deflation. You haven’t had that panic yet.”
* His biggest risk to watch for is the extreme negative positioning in bonds (everyone is short, betting rates will rise). He thinks the shock of US treasury yields converging on Japanese-level yields will overwhelm us and “the markets will riot.” His other two big risks are China GDP disappointing (further pressuring global prices, demand) and the fact that US stocks are so elevated in valuation that we don’t need a recession to crash, just the fear of one.
Nothing he’s saying is entirely unreasonable. Again, this comes back to the likelihood of the negatives coming true and dominating the positives.
Over at Bloomberg News, there is a sense that the bond market hasn’t been this pessimistic since 2008. The reporters collect several opinions from people regarding whether or not the “strong” US economy can continue to diverge from deflationary pressures in Europe and in the commodities market. The consensus seems to be that, no, we cannot. The “soaring” demand for Treasurys of intermediate and long-term maturation makes it pretty clear where the bets are. Never mind that this conflicts with Albert Edwardseseses’s contention that everyone is short rates right now.
Some stats on bond market demand / inflation expectations from the article:
Demand for Treasuries has soared this year, pushing down yields on the 10-year note to 1.84 percent through last week. Those on the 30-year bond slumped to 2.35 percent, the lowest since the U.S. started regularly issuing the securities in 1977.
Yields were 1.82 percent on 10-year notes and 2.43 percent on 30-year bonds today as of 8:29 a.m. New York time.
Based on prevailing yields, bond investors see cost-of-living increases staying below the Fed’s 2 percent annual target for at least 30 years.
Lastly, let’s touch on what Gerald Minack is saying. For the uninitiated, Minack was a strategist at Morgan Stanley who retired to his native Australia 18 months with a phenomenal track record as a skeptical, yet pragmatic, bear. Last week he was interviewed by an Australian paper about the biggest risks to the global economy going forward and had the following to say…
GM: In a way I think we are all turning Japanese. In the 1990s when they first tackled their bubble – and it was world’s best-practice bubble, it was spectacular! – initially most analysts, myself included, applauded. It looked like they had let the air out gently without a recession: rates and growth came down and unemployment did not go up.
But the point was that it was the second downturn in ’97 that nailed them; only after then did the Japanese “turn Japanese”.
Now, we’ve shot a lot of bullets in the global financial crisis and the next downturn I think will reveal most other people are turning Japanese. Unfortunately the one policy that blindingly obviously works is fiscal policy, but it’s very unlikely to be doable in the next downturn; in the US due to congressional gridlock, and it will be disabled in Europe because they won’t have a centralised fiscal authority.
So you’re left response-less when you enter the next downturn, with monetary policy that is ineffectual, unconventional monetary policy that’s just embroidery, and very close to deflation.
AFR: Most investors would share to a large extent many of the views you’ve described – does that mean we’re all bears now?
GM: The funny thing is there is a disconnect between what investors are saying and what they are doing. No one thinks all the problems the global financial crisis revealed have been healed. But when you have an equity rally like you’ve seen for the past four or five years, then everybody has had to participate to some extent.
What you’ve had are fully invested bears.
The question inherent in his statement is whether or not there is anyone left on the bearish side of the trade? When even the skeptics are dancing to the music (they have to be in at this point because of career risk), who’s left to cushion the blow should things unravel?
None of these opinions should generate panic, but all are worthy of consideration. Bears want that D really badly, because it’s the only saving grace for having “missed out” left to them. If recessions are caused by the end of the business investment cycle and plunging prices are the most likely thing to trigger the waning of that cycle, you’ll understand why they’re all grasping for it with both paws.