An Interview with Peter Cardillo Chief Market Economist, Avalon Partners

Includes: DIA, QQQ
by: Hard Assets Investor

Mike Norman, (Norman):  Today my guest is Peter Cardillo, chief market economist at Avalon Partners.

Look, you’ve been in the business a long time, Peter, you’ve been in the business a very long time. Tell us your thoughts about what we have gone through recently, particularly this enormous market plunge, not just in stocks but in all asset classes. Have you seen anything like this in your career?

Peter Cardillo, chief market economist, Avalon Partners (Cardillo): Percentagewise yes, of course, but you know, in such a short period of time, the answer is absolutely no. I have not gone through anything like this before in terms of market declines, of the market losing 20% in one week; that never happened before, and of course the reason for that is, obviously what we had out there was a fear factor that was gripping everyone, and of course, with the credit market seizing up, that just added even more fear out there, and then of course the blowing up of a lot of hedge funds didn’t help either. That’s probably one of the reasons why we saw this market dive the way it did.

Usually the markets always discount, and this market has discounted a lot of things, just recession, and probably even a recession is going to be a little bit more severe than we previously were contemplating, but nevertheless, as I said, the way the market dropped, you might say, fast market action that we had, and the volatility that we had was all due to this unwinding of assets, whether they were equities, bonds or hard assets, commodities, you name it; it went all down at one time.

Norman: Except for the highest quality, like Treasuries. Where are we, do you think, in this whole process? You sort of alluded to perhaps that the smoke may be clearing. We’ve discounted a lot, we’ve discounted perhaps a very, very deep recession, and as you mentioned, investors have pulled out of assets of all classes with the exception of the safest, most liquid. Where are we now, in your mind, in this process? Are we in the middle, are we still in the early stages, or are we closer to the end?

Cardillo: I think we’re closer to the end of the crisis as we know it. In terms of economic activity, I think it’s going to be at least two or three quarters of some real tough going here. We’ll probably see unemployment climb above 7.5% and we’ll probably see inflation really fall off a cliff.

Now there’s a positive side to that, and of course there’s a negative side to that. In fact, I think if you read between the lines, if you heard today Mr. Bernanke, obviously you know he’s for another stimulus package; why is he for that? Very simple: Because he knows that we’re in for some rough times here in terms of economic activity, and the greatest fear out there - although I believe it was avoided - was a deflationary period. Yeah, I think that was avoided; I really do.

Norman: Through the actions taken by the Fed and the government and other central banks, you mean?

Cardillo: Absolutely; there’s no doubt in my mind that if we didn’t have those actions, this market could have been really down even another 20%, 30%, maybe 40% from these levels.

Norman: Some say that the government intervention in all its forms - the central bank and the federal government - is a negative thing. Do you agree or disagree with that?

Cardillo: No, I think it’s a positive, but it does have some negative implications. Obviously somewhere along the line, when we do get back on track, the government, the Fed, is going to have to fight inflation and not disinflation or deflation. You’re printing money, you’re creating deficits that have gone into orbit, and that’s not a positive, that’s always a negative.

But as I said before, right now they needed to avert a serious deflationary spiral within the economy, and I think they’ve done that, not only here domestically, but on a global scale as well. Look, you saw the numbers out of China; growth is at 9%. Now 9% is pretty strong, but by the same token, for an emerging market, that was almost at 11%, 12% - it’s down rather sharply.

Norman: A big surprise there, no question about it.

Norman: Peter were talking about the Fed and other central banks and actions by the government that have prevented a deflation. Now leading up to this, over the past five or six years, the big concern has been inflation. Indeed, we've seen materials prices rising across the board, a lot of concern about inflation, we've seen a fall in the exchange value of the U.S. dollar. All this happened very quickly, this sudden idea or notion of a deflation.

Cardillo: Well, obviously, you know, when you have the credit markets seizing up and no one is willing … when the banks are not willing to lend to each other, that's a serious problem. Look, what we went through … there were signs of what happened in the early 1930s, there's no question about that. However, I think that the governments certainly have learned the lesson now in terms of avoiding a deflationary era, and that's why I think the fact that they came out with all these stimulus packages, rescue packages - whatever you want to call them - basically is the right thing at the right time.

Now, grant you, maybe the Federal Reserve and the Treasury were a little bit asleep at the wheel in the sense that they should have seen this brewing, because we had excessive real estate speculation. And unfortunately, the former maestro who created this - Mr. Greenspan that's right, who basically is somewhat responsible for this - up until his last months in office he always said, well, we have a slight bubble in the real estate market in certain areas of the country, but we don't have a real bubble.

Obviously that is not the case and we did have a bubble. But the problem is that no one knew the extent and the depth of the problem until it finally nearly collapsed the system.

: Now prior to this implosion, some of the best-performing asset markets were raw materials, commodities … this idea that we have a lot of emerging new economies, developing economies; you mentioned China, India for example. Those have been some of the hardest-hit markets on the way down. With the efforts now by the Fed and other central banks and governments to sort of reflate the system to avert a deflationary collapse, will these markets and these countries resume as the leaders?

I think they will, but it's going to take some time. I think we can see the equity markets regain over a short period of time. I wouldn't be a bit surprised to see us recapture Dow 10,000 very shortly, but this bear market that we're in - and this is a global bear market, it's certainly not only domestic, that's for sure - is going to take a while. This bear grip that we have is not going to let loose, but we'll see an improvement. I think we'll see an improvement not only in prices but in psychology, and the key is confidence, restoring confidence, and we're beginning to see that.

If you look at the overnight interbanking lending, you'll see that the spreads are beginning to narrow, and once we get them down to levels where you'll see the credit market unclog and banks begin to lend again, that will be the key; the confidence restored in the credit markets.

Do you think what has transpired will lead to sort of a fundamental change in the way we view markets, away from this sort of free-market fundamentalism, as it's called, to where you have markets much more regulated and managed by authorities, governments, central banks, whatever?

Well, if you're asking me do I think capitalism is dead, the answer to that is no. Are we going to have a shift; are there going to be a lot of regulations? Yes, but I think this so-called small part of socialism that we may have entered will not be long-lasting; I think it will be short-lived.

: All right, thank you very much Peter. Well, you heard it here: Capitalism is not dead, folks, so stick around here, come back; we're going to have a lot more on this interview series. Thanks for stopping by. This is Mike Norman; see you next time.