Is This The Onset Of Realism - Or Am I Just Fooling Myself?

by: Jeremy Robson

My father was a Yorkshire man and I think I have inherited some of his traits. In England, Yorkshire is known to be a hard place for salesman. If Yorkshire people cannot taste it, feel it, smell it or hear it, they certainly will not buy it! They have earned the reputation of being the most realistic people in the UK, none of the guff (guff is a word used in the UK for salesman's patter) gets through in Yorkshire.

What, you may ask, has this got to do with finance? In my opinion there is a lot of guff out there at the moment. In particular the following does not add up:

1. The US economy is accelerating and about to achieve escape velocity - If you tried selling this idea to a Yorkshire man, he would quickly point out that an economy that has a budget deficit of 8.5% of GDP and growth in 2011 of 1.7% is not an economy that is likely to be primed for takeoff.

2. QE increases asset prices - This might take him a little longer to figure out.

'Inflation is always and everywhere a monetary phenomenon in the sense that it is and can be produced only by a more rapid increase in the quantity of money than in output' said Milton Freidman.

If we accept that money creation is greater than output at the moment (which it is), the result is inflation. How do markets react in times of inflation. They are at best choppy (best example is the 1970s), inflation is certainly not bullish for equity markets. It would seem that this argument relies on there being no central bank response to inflation when it arrives. Sounds like guff to me. By the way I do not think that the present QE will lead to high levels of inflation at present. The levels of inflation will just be higher than they would have been if the QE had not been introduced, but still low. However the argument above is valid for those people who are predicting higher asset values as the result of QE.

The next argument is that QE has reduced the stock of safe assets and is forcing people into assets that they do not want to own, but are owning, as they see that it is the only way to make a buck. Isn't that what salesmen do, they get you to buy something that you do not want, because you are persuaded that it is a good idea. Are these people strong longs or will they sell at the first sign of trouble. Seems like guff to me! Jo sixpack has been reducing his allocation of stocks for over a year.

Lastly and the one that will get even a Yorkshire man is that the 2 episodes so far have made asset prices go up. QE has got even the uber-bears (Hussman, Rosenberg, Biderman, Roubini and Mauldin) buying stocks. You feel so foolish (as I am constantly finding) predicting the markets are going to fall and then finding that they go up in response to the latest government injection of liquidity. However, I figured out some time ago, that the rapid rise in the markets in 2010 and 2011 was primarily down to the fiscal stimulus enacted in 2009. It is all gone now and there is zero chance of any more. Growth slowed to 1.7% in 2011 as it's effect has worn off. The markets have continued their ascent, despite reduced growth, as profit margins have continued to improve. That game is now over as well, margins will stay high but there is no more juice in the margin tank. I have predicted on a couple of occasions, that the next QE has a very high chance of failure. I hold to that view. There will be a pop, but I don't think that it will be lasting. There is probably one more up move in this market to come on the QE story and then reality will set in. You see, I have inherited the traits of a Yorkshire man and I am not interested in the guff, I don't buy the salesman's chatter.

3. Hyperinflation is coming to the US - Well if US politicians act like third world politicians or there is a third world war it might do. My estimate of either of those possibilities is zero and zero. If there is no voluntary fiscal deal out of congress, one will be forced on the US by the markets. The chances of the Fed monetizing enough of the US debt to keep America with affordable rates for the next 20 years (as has been done in Japan) without a fiscal deal is also around zero. One of the roles that the Fed has adopted in the past is the policeman of the nation. Volker did it in 1982 and in time the Fed may be forced into the role again. I am confident that there are enough checks and balances in the US economy to prevent hyperinflation.

4. The US dollar is doomed - Guff!! The US has been and will continue to be one of the most successful economic nations. The US, despite constant moaning of the opposite, has the lowest tax take, the smallest government, the least expensive welfare state, the most business friendly employment rules of virtually any western economy. It is mean and lean and will remain one of the most successful of the western economies. Unfortunately it has had the same debt induced asset price bubble, that nearly every other western economy has had and it will face the consequences for it's past mistakes. The next few years will be hard, but the US will survive better than most. In the present environment the dollar will not fall substantially. The yen will, but the dollar will not. It is only after this crisis has passed that the dollar will fall as a result of it's balance of payments problem. Whilst the crisis lasts, demand in the US will remain weak, leading to a reduced trade deficit and a stable dollar.

5. The US will lead the world out of it's problems - This is probably the best of the lot. The US has the same debt problems that the rest of the western world has. In relation to public debt, it's problems are worse. Growth will remain weak for the next 5 years at least, until the excessive debt load is worked off. When the US either chooses, or is forced by the markets, to reduce it's budget deficit, this story will be over. This is an event that I feel is likely soon after the next presidential election in November.

6. When the US congress negotiates a budget deficit reduction package, the market will celebrate this historic event with a substantial rise - In my opinion if the US congress negotiates a meaningful fiscal retrenchment, you should be running for the hills at the fastest rate you can muster, as this will signal the start of the next serious bear market. Once government support is withdrawn the private sector will have to create the demand and it will not be ready. If there is a celebratory rise in the markets, it will be one of the best shorting opportunities for many years.


There is a lot of guff at the moment. I guess it is because the financial world wants and needs asset markets to be constantly rising, as this is the environment in which it makes money. Sad but true! Will I be right and realism sets in or will the financial salesmen make their 'guff' stick and allow asset prices to move substantially higher on liquidity and a prayer. Only time will tell, but I sense that my time is approaching! If I am right and realism returns to haunt us, it will likely be here to stay for some while, measuring years rather than months.

Disclaimer - This article is not intended as investment advice. Before taking any action, please do your own research. Do not rely on any opinions or facts included in this article for decision making.

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

Additional disclosure: Long RWM, RIMM short EUR/USD