by G. C. Seifrit
“There is always a brighter tomorrow. Besides, history is replete with proof that some of the best opportunities occur in moments of great uncertainty and crisis.”
In the first two installments of our three-part series, we looked at the truth of the implacable global debt problem and considered the unexpected economic consequences the current policies and actions to resolve it are producing.
In this final chapter, Part 3 discusses the ramifications of the untenable debt and the ‘debt fixes’ from a market perspective. We offer our view of current market dynamics and suggestions for the investment climate we see unfolding.
As outlined in Parts 1 and 2, our view on global debt and the economy runs against the grain of many mainstream economists, market pundits, and the official body politic. Though unpopular, we believe it is a realistic viewpoint that expresses the truth and consequences that few choose to acknowledge or consider.
We see no panacea for the global debt ills because frankly there is no definitive cure. Here-to-date ‘stop-gap’ measures and policies are insufficient to deal with the real underlying issues. To a large degree, central bank actions have bordered on ‘experimental.’ Though they are providing temporary support, they have unintended consequences and uncertain long-term outcomes.
There is no curative prescription, though many would have us believe so. We see little possibility of an immediate or painless resolution to the overwhelming debt issues and the anemic economic reality they are creating.
We believe the difficulties are not over. The tentacles of the 2008 Financial Crisis and the massive expansion of debt that created it will likely have a stronghold on the world for the foreseeable future – in financial, economic, political, and social terms. All this speaks to continued uncertainty and volatility – perhaps in ways still unimagined, and impossible to predict.
In the face of present and future uncertainty, individuals need to consider the implications of the debt problems from a realistic economic perspective in order to prepare for a future path that remains insecure and dotted with unseen potholes.
The ‘New Normal’
Today the economy and financial markets continue to exhibit the effects of the 2008 Financial Crisis and the falling dominoes of its aftermath – a direct result of two decades of profligate global credit creation. Through excess and short-sighted management, the world racked up an astonishing amount of debt. By some estimates, today’s global credit market debt exceeds US$ 200 Trillion (330% of the world’s total GDP).
A myriad of ancillary difficulties (consequences) continue to surface in a world overwhelmed by debt and stymied by the morass of problems it has created. Complicating matters more, we fear the supposed debt ‘solutions’ are only exacerbating the situation. The mountain of debt, and how to deal with it, are at the root of the problems. They are defining today’s financial markets, world economies, and the economic future.
In 2009, as financial markets and global economies were reeling from the effects of the Financial Crisis, renowned investment firm PIMCO ($2 Trillion under management) coined a phrase that aptly describes the post-Crisis global economy: the ‘New Normal.’ This moniker has been adopted by many for its description of the new economic realities of the post-Crisis world.
In retrospect, Neel Kashkari, former Assistant US Treasury Secretary during the Financial Crisis and today a senior member of PIMCO’s management team, recently outlined the implications his firm envisioned for the New Normal world they saw unfolding:
“The New Normal called for long-term deleveraging that would lead to lower growth than society had been accustomed to. It called for more modest investment returns across asset classes, as the leveraging of the economy reversed course. It called for increased regulation and reduced globalization. Most importantly, it said there would be no V-shaped [economic] recovery that is typically seen after a recession. It would be a long, hard adjustment period with sustained high unemployment. It also called for a transition from private balance sheets to sovereign balance sheets.”
Today, Kashkari accurately points out that PIMCO’s 2009 vision of the post-Crisis economy and financial market dynamics was correct on all counts. However, the problem is that the ultimate effects (outcome) of New Normal central bank policies and regulations instituted to deal with the Crisis aftermath have yet to be determined or understood. In essence, we are living – and investing – in a “Brave New World.” Just as the post-Crisis financial landscape remains uncertain, investment guidelines for the New Normal environment are unsure.
Deflation and Inflation
There are no clear answers because there is no available playbook to successfully guide us through the historically unprecedented events of the past five years and the resulting market dynamics they have created. We are navigating in uncharted waters.
Many financial unknowns and market variables enter the equation. Political uncertainty, international unrest, and unpredictable societal developments also come into play. The litany of question marks makes opinions and prognostications of economists and market advisors little more than educated guesses.
In the midst of such uncertainty, it serves well to focus on what we believe can be defined with some degree of clarity.
Since the Crisis, a chief question among economists has been whether the New Normal environment was creating a cycle of inflation or deflation. In our view, the answer is not an either-or, mutually exclusive outcome. One result does not preclude the other, particularly if these two clearly opposing conditions are understood as both being similarly created by the current central bank monetary policies, but which will manifest individually in causal succession over the economic timeline. This is precisely what we foresee unfolding: deflation and inflation, in succession.
From a global macroeconomic perspective, we envision a prolonged deflationary cycle (today), followed by a period of significant inflationary pressures (5-7 years out: the future).
However, today the majority clearly view inflation as the sole threat. They believe any deflationary pressures brought on by the initial Financial Crisis were quickly subdued and of little concern today. Seeing global central banks as having successfully squelched the deflation threat by slashing interest rates and orchestrating massive, ongoing liquidity injections, they reason the deflation risks are eliminated. Instead, they maintain that the unprecedented monetary maneuvers are igniting inflation, which in their view is the real current threat to global economies.
Though many deflation indicators may appear to have dissipated, we believe overwhelming evidence indicates that the post-Crisis deflation trend never truly ended. It has only been artificially and temporarily subdued by overwhelming monetary intervention – quantitative easing’s (QE’s) and near-zero rate policies.
Since the Crisis, central banks have artificially supported asset prices (particularly financial markets) through massive injections of trillions of dollars, yen, and euros. Despite their Herculean efforts to stimulate, they have not succeeded in sustainably reflating the economy, nor have they resolved the real issues of the unsustainable debt. Global economies must work through the debt issues if we are to move forward with any lasting degree of economic success!
For this to occur, a prolonged period of significant global deleveraging (debt defaults) and accompanying asset price adjustment (value destruction) is required. Whether controlled or not, until the process is complete, global deflation remains our true and present nemesis. A period of deleverage and deflation – not inflation – is the expected and necessary post-crisis phase that naturally follows a massive credit bubble collapse, like the historic one just witnessed in 2008. There is a wealth of economic theory and precedence that supports this scenario. Ultimately, we believe central bank monetary manipulations can do little to change this natural equation. (We suspect central bankers fear this as well.)
The arguments supporting inflation indeed have sound reason. It seems implausible that unparalleled monetary easing (money printing) would not eventually lead to inflationary pressures. From our perspective, however, inflation is not the current concern, or an imminent threat. Deflation is.
A cycle of inflation will arrive – perhaps, with a vengeance – but only after global economies have been ‘cleansed’ by an important and prolonged period of debt deleverage and asset price deflation.
From our perspective, there is no alternative outcome than the one we describe. Given the severity of the world’s debt troubles and the degree of systematic cleansing required to restore economic vitality, the ability of central banks to sustainably ‘reflate’ world economies with massive liquidity injections – but no true structural (debt) resolution – remains extremely doubtful. A global cleansing is required and will occur – whether orderly or not.
Cover your assets
For investors today, the battle between the artificial support of central bank monetary policy and the ‘natural’ economic functioning of global markets (the necessary ‘cleansing’) means continued uncertainty and volatility that will have an important impact on financial markets and all investment portfolios.
Mohammed El-Erian, CEO and Co-CIO of PIMCO, postulates an investment thesis to which we subscribe:
“We could well see more investors seeking less risky asset allocations, including cash in what they deem as ‘safe jurisdictions.’ In the process, valuations — for bonds, commodities, currencies, and equities — could well diverge for a while from what many deem to be historically fair valuations.”
Reading between the lines, El-Erian appears to similarly contemplate a scenario of deflation as being the immediate threat for global economies. The implications of global deflation can be severe, even devastating. History provides us an example in the Great Depression of the 1930’s – and its aftermath. The possibility of global deflation provides reason to reconsider Will Rogers’ observation from that earlier time that investors should be concerned with ‘the return of their money and not just the return on their money.’ What is the investor to do?
Though this public forum is not the appropriate venue to offer specific investment advice, there are general themes we highlight for the deflationary environment we believe is at hand.
Liquidity: From our vantage point, the primary concern is liquidity, i.e. availability and access to cash or cash equivalents. In a deflationary environment, having liquidity is an important consideration. With the global deleverage (debt restructure and default) we envision, most asset prices will fall – perhaps considerably. As an example, what happened to real estate prices in many regions of the globe over the past six years can be seen as an explosive ‘first act’ to the global deleverage screenplay. Deleverage and concurrent deflationary expectations will expand to include other asset classes as well. The show is not over.
The deflationary period we foresee will be indiscriminate and affect the values of virtually all asset classes – financial and non-financial. This indicates the advisability of increasing one’s liquidity today by the divestiture of non-productive or unessential assets before prices experience a more important decline. This is especially true for ‘trophy’ assets like fine art, collectibles, gemstones, and even precious metals. As we described previously in Part 2, we view current equity market valuations as clearly unreal (a bubble) and principally the result of excessive central bank monetary intervention (money printing).
In addition to protecting current wealth from erosion as asset values fall, those who build liquidity today will have an advantage in the ‘cash-squeeze’ of a deflation cycle, as well as better access to the generational investment opportunities to be found at the cycle’s nadir.
Diversification: Go beyond the well-intended rules that advise portfolio diversification among traditional assets. We follow a methodology and models that also seek diversification among currencies and non-traditional assets. Seek investments that have little or no proven price correlation to traditional asset classes or the market, thereby providing the possibility of greater value – both as independent investments, as well as stabilizing additions for an entire portfolio. Correlation of investments – the degree to which values move in tandem with other assets or a market – can be an important element for wealth protection (and profit), though admittedly an imperfect one. For many but the most experienced investor, here it is important to have professional advice and assistance.
In addition to a more meaningful diversification of investments, the New Normal also calls for serious consideration of the diversification of banking relationships and even the geographic location of one’s physical assets and personal financial wealth. Security and stability are paramount for wealth preservation. Unfortunately, in today’s world, trust in the viability (strength) of financial institutions, national currencies, and even sovereign governments is clearly an important consideration.
“The Sun will come out tomorrow”
Finally, the best advice for investors in all economic climates is simply to recognize what makes you feel comfortable. After all, it is your money and your financial future.
Regardless of one’s views on the economy, financial markets, and alternate investment theses, all investors should always consider the following:
• Consult with an experienced professional investment advisor, consultant, or private banker. If you do not have one, find one you can trust and rely upon.
• Choose only investments you understand and those you feel comfortable with. Know your ‘risk profile’ and the level of your ‘risk tolerance.’ Ask yourself if your investments allow you to sleep well at night?
• Information is knowledge, and staying informed is imperative. Seek opinions from multiple sources and professionals with differing viewpoints. Ask questions. There is no such thing as a stupid question.
Though uncertainties abound and the future may seem unsure, the world is not ending. There is always a brighter tomorrow. History is replete with proof that some of the best opportunities occur in moments of great uncertainty and crisis. Those who are informed and prepared – realistic in viewpoint – are often the ones who manage the best.
Note: The opinions expressed are solely those of the author and do not necessarily reflect those of any institution or organization with which the author has an affiliation. The viewpoints of the author are offered solely for informational purposes and in no way constitute an investment recommendation or investing advice, and should in no way be construed as such by the reader. Always consult with an investment professional or financial advisor before making any investment decisions.
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