Chris Lau - Seeking Alpha

Sunday, April 19, 2009

The Trend is Your Friend

Notes from Frontline Weekly Newsletter

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The Trend Is Your Friend Until the End of the Trend

Stability, though, as we were taught by Hyman Minsky, leads to instability. The more stable things become and the longer things are stable, the more unstable they will be when the crisis hits, because we human beings learned to trade and invest by dodging lions and chasing antelopes on the African savannah. We now chase momentum and dodge bear markets. We are hard-wired to look around at our circumstances and predict trends far into the future.

We take the current trend and we project it forever. But the one thing we know about trends is that they are eventually going to end. The trend is only your friend until it ends. Trends are notoriously fickle. That stability breeds instability.

...

We have two trillion dollars of actual cash propping up $50 trillion in credit. If we all decided to settle and pay off everything, we couldn't do it because there is not enough cash. There would be massive asset deflation. We, as a nation, are levered 25 to 1, or we were. Now, that $50 trillion is in a real sense the money supply because that is what we are all pretending is real money. I lend you money and you pretend you are going to pay me back. Then you pretend he [pointing at another attendee] is not going to call your debt for cash, and we are all going to keep the system going. Because if we all try to pay each other back at once, we are all collectively -- and this is a technical economic term -- screwed.

So we keep the system going. Now, where are we today? We are at the Great Deleveraging. We are seeing massive losses and destruction of assets, on a scale that is unprecedented. There was massive destruction of assets during the Great Depression, which caused a lot of problems, and we are seeing the same thing today.

...

This is not just in the US, but all over the world. Because when you start adding European cash-to-credit, and Japanese cash-to-credit, and Indonesian and Chinese cash-to-credit, it becomes multiple tens of trillions, and we are watching a goodly portion of that credit be vaporized. So we -- individuals and businesses -- are trying to find that $2 trillion in real cash and get some of it to pay down our debts.


My Comments:

There is no better word to describe the situation. As Mauldin puts it...we are all screwed.

One best not lose sight of the sell-off proceeding the stock market recovery. The key word is de-leveraging. The money created may necessarily require stocks in finance and real estate to rise, but the real factors governing current economic health - employment and housing - will need to be priced in the market.

$300 billion is just a down payment on the "quantitative easing" they will eventually need to do. They can't announce what they are really going to do or the market would throw up. But we are going to get quarterly or semi-annual announcements, saying, we are going to do another $300 billion, another $500 billion.

When we first started out with TALF and everything, it was a couple hundred billion here and there, and now we throw the word trillions around and it just drips off of our tongues and we don't even think about it. A trillion is a lot. It's a big number. And the total guarantees and back-ups and all this stuff we are into -- I saw an estimate of $10-12 trillion. That's a lot of money.

Understand, the Fed is going to keep pumping money until we get inflation. You can count on it. I don't know what that number is, I'm guessing $2 trillion. I've seen some studies. Ray Dalio of Bridgewater thinks it's about $1.5 trillion. It's some big number, some number way beyond $300 billion, and they are going to keep at it until we get inflation.

My Comments:

A big debate going on right now is whether we will face inflation or deflation. Knowing which way it will go will alter the allocation of resource holdings in a portfolio. The rule "Don't Fight the Fed" still applies.

Will it create an asset bubble in stocks again? I don't know, it could. Dennis [Gartman] talked about being nervous yesterday. I would be nervous about stock markets, both on the long side, as I think we are in a bear market rally, but also there is real risk in being short. Bill Fleckenstein will be here tonight. He is a very famous short trader. He closed a short fund a couple of months ago. He says he doesn't have as many good opportunities, and basically he's scared of being short with so much stimulus coming in. So it's going to work, at least in terms of reflation, but the question is when. A year? Two years?
My Comments:

With so much money added to the market, investors have already seen its positive impact on stocks in consumer goods, financials, and in real estate. Since it is not known just how much more money will be added to the system, short-selling is dangerous. Hedge ETFs are safer in the sense that losses are capped. Many of them are still good to hold in small amounts to manage portfolio risks against long positions.

About Growth in China

One note from today's data on deflation. The headline in the Wall Street Journal says China grew at 6.1% last quarter. That doesn't sound bad. But what was not in the story is that nominal growth was just 3.7%. The other 2.4% was because of deflation. To get real (after-inflation) growth you subtract inflation and/or add deflation. Growth in China is slowing down more than the headlines suggest.


My Comments:
It is good to know now that deflationary forces add to reported growth, even though this growth isn't "real."


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