The Return Of The Recession/Disinflation Bias

by: Paul Nathan

US growth rates of 3% and inflation rates of 4% peaked in the fourth quarter of 2011. Both are running at 2% now and may be moving toward zero or less. Events and policies--or the lack thereof--will determine if growth and inflation actually get that low or not. While there are many ways to interpret today's economy and monetary landscape, there is no denying that we have returned to the recessionary/disinflationary bias of the past. The trends of both growth and inflation are clear. They are falling.

Resource stocks, among other sectors, have been signaling the change since last February. Plunges of 40 to 60% in many stocks have people scrambling to get a bead on the economy. With the decline in both growth and many consumer prices, the rush is on to handicap the election results, to determine the overall direction of the stock market, to gauge the degree of future deficits and debt, and to anticipate any possible change in tax and monetary policy. Will we continue to fall and go into a new double dip recession? Or will we accelerate to escape velocity and return to a normal "orbit?"

I say neither. Why? Things aren't bad enough for the Fed to take exceptional measures, or good enough for growth to reduce unemployment. For years I have been describing this state of limbo as "A World of L." In this world of L, most nations are just muddling through. None are vigorously expanding. Europe has morphed from a region in monetary crisis to one in economic demise. The contagion that plagued banks and the financial system was ring-fenced, but only to be replaced with nations slowly stagnating. L-shaped growth has left the world weak, and while it hasn't flat lined yet, it isn't nearly strong enough to lift itself and walk on its own feet either. In other words, the world is alive but not well.

Stagnation in real terms means 0 to 2.5% growth for as far as the eye can see, with continued high unemployment. We must grasp that until economic, fiscal and monetary policies change, the world's path cannot. Within this stagnant deleveraged context, economies and peoples will continue to be thrown about like skiffs on high seas.

As an investor, anticipating the effects of this world of L has meant playing resource stocks from both the long and short side. Weathering stagnation has meant being anywhere from 100% cash to "all in" at other times. And just like that skiff in stormy waters I've had my share of battering, but staying flexible as an investor has helped me keep my head above water.

We investors belong to a kind of special club. Always on the lookout for the next big success story, we not only reject failure, we punish mediocrity. Failure to perform always results in immediate rejection by any market. Further, in looking for the "best investment," we tie our individual fortunes to the private sector. Whatever our political or economic beliefs, as investors we respond to success and to productive companies. In this way we survive and prosper just as the companies themselves must continually adapt to survive and prosper.

Although caught in this world of L, it is important to understand that it contains two very different elements. There is the government sector--bloated, overpaid, unproductive, unprofitable and in debt up to its ears. And then there's the private sector--lean, mean, profitable, cash rich, productive and dynamic. Also important to remember is that despite it seeming that the mission of government today is to tell individuals what to do, how to do it, and at whose expense; individuals and businesses are just as determined to avoid all these government edicts. And in this country at least, they're pretty darn good at it!

The public sector and the private will no doubt continue to grow apart. As one struggles in its own mess, the other somehow continues to produce and overcome the many obstacles the other places in its path. By continuing to invest in winning companies we support the only real effort capable of lifting the world back on its feet. Governments can't keep down the private sector in the long run.

That's obvious when comparing the results of bureaucrats and regulators with those of the private sector. And considering that government only "grows" at others expense while companies must enrich others or die, it's no surprise government goes deeper and deeper into debt while companies like Apple (NASDAQ:AAPL) run surpluses most nations would envy. Wouldn't the US love to have Apple's balance sheet!

We have indeed returned to a recession/disinflation bias in the economy. But we didn't succumb to it in the last four years (the market has doubled), and we won't remain passive for the next four either. No matter what happens, we investors will stay on the lookout for good companies that are growing, creative, and profitable.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.