Monday, August 2, 2010

fear subsides, prices rise



I haven't posted this chart in a while, but I think it is significant that the story it is telling hasn't changed for the past two years: the ups and downs in the equity market are strongly correlated with the market's level of fear, uncertainty, and doubt (as expressed by the Vix index). The market went into a mini-panic last May, but fear is slowly dissipating, and prices are beginning to move back up. Why? Europe didn't melt down; commodities didn't collapse (in fact they are rising nicely); the U.S. economy hasn't double-dipped (in fact it is doing better than expected); and policy errors that could really threaten growth—like cap and trade—aren't happening.

The one cloud that remains on the horizon is the expiration of the Bush tax cuts at the end of this year, but the political winds continue to blow in a favorable direction on that score (i.e., the growing likelihood of big Democrat losses this November), and if more people can apply common sense, facts, and logic to make the case for not increasing taxes and instead for cutting spending, like Art Laffer does in his WSJ op-ed today, then investor confidence in the future could really start to improve.

The market is suffering from the "once burned, twice shy" syndrome. The majority of people are still terribly afraid that something else is going to go wrong with the economy. All it takes for prices to move higher is the realization that the market's worst fears aren't materializing. Now, if we could actually get some really positive news, imagine the upside potential!

9 comments:

Benjamin said...

See page c1, today's WSJ. Pimco's Bill Gross, who hails from Grannis' OC, says we are in feflation now, and he is investing accordingly.

John said...

Benj,

It is always a good thing to know what Mr. Gross is thinking. However one should keep in mind he runs a HUGE bond house. Constantly warning of the deflation booger keeps his investors frightened and close to (his) home. I'm not saying what he says is wrong, just that what he says is strongly influenced by his interests and should be taken into account when reading his opinions.

Bill said...

Of course Benji fell for Gross's agitprop hook, line and sinker despite all of the evidence that inflation, not deflation, is the current and future status for the US economy. The temporary deflation we have suffered in the past 2 years in some sectors of the economy was a result of a market correction which has now ended and inflation has resumed its 10 year march.

Benjamin said...

John-
Years ago I interviewed Gross, and he struck me as a thoughtful and principled individual. Maybe I was fooled, who knows. Jeez, the guy has made enough money he does not have to turn tricks anymore, he can say what he thinks.

There seems to be a growing consensus among some faily "conservative" (small c) investors/policymaker that deflation is real, such as Bullard of the St. Louis Fed. These are not wild-eyed pundits.

Bears watching. For myself, I think we are in deflation, and given the Fed's resolve to fight the last (as in previous) war, we may see a deflationary recession.

Real estate is dead, wages are dead, rents are dead--poof.

John said...

Benj,

I am sure Mr. Gross is every bit what you say. I did not mean to imply otherwise. Everyone is influenced by their interests. Mr. Gross is no exception (nor am I).

I believe you when you say there is currently no upward price pressure on rents, wages, etc. However if we can be certain of anything in this world it is that things change. Perhaps too slowly to suit many of us, but change is happening all around us every day.Successful investing often requires great patience and sometimes suffering. To me (and I believe Scott also thinks this) the signs are pointing unmistakably toward reflation of real assets. Hang in there. It may take some additional time but better days are ahead.

Scott Grannis said...

Deflation is properly defined as a decline in the general price level: a decline in all prices. That is most certainly NOT happening today. Gold is way up, commodities are way up, many currencies are way up against the dollar, wages are rising, the CPI is rising, the GDP deflator is rising, and the PCE deflator is rising. Plus, all measures of money are rising, and the Fed is trying harder than ever to make sure that prices rise instead of fall. To insist that we face deflationary risks is to ignore the facts and succumb to the popular fears, and to ignore the power of the Fed to get whatever it wants.

The "deflation" we see is not a general deflation, it is a decline in some prices relative to others, notably real estate and real estate-related things. This sort of thing happens from time to time. But it should not be mistaken for deflation.

Scott Grannis said...

Deflation is properly defined as a decline in the general price level: a decline in all prices. That is most certainly NOT happening today. Gold is way up, commodities are way up, many currencies are way up against the dollar, wages are rising, the CPI is rising, the GDP deflator is rising, and the PCE deflator is rising. Plus, all measures of money are rising, and the Fed is trying harder than ever to make sure that prices rise instead of fall. To insist that we face deflationary risks is to ignore the facts and succumb to the popular fears, and to ignore the power of the Fed to get whatever it wants.

The "deflation" we see is not a general deflation, it is a decline in some prices relative to others, notably real estate and real estate-related things. This sort of thing happens from time to time. But it should not be mistaken for deflation.

Benjamin said...

Unit labor costs are going down, not up. The CPI is down three months straight. Gold going down now. Steel very soft.
Real estate--I won't even talk about it, but further liquidations could be in store, in commercial, retail, industrial. I hope not.

Well, time will tell. But when a Bullard and a Gross talk deflation, I would put a fresh and wet finger in the wind.

John-I keep hoping for that big long bull market in real estate and stocks, caused by low interest rates that could stay low for a generation. I am worried we will step in a deflationary quicksand hole first. Interesting times. In any event, I hope your investments do very well.

John said...

Benj,

Thank you.

A global business outlook survey is periodicly conducted by KPMG. The results for the July survey show business confidence continuing to increase (despite the consumer going in the opposite direction). Manufacturing executives are steadily increasing hiring (mfg. is ~12% of GDP) while services are holding steady. The only country that registered higher business confidence was Brazil. Germany's was the highest since 2007. Apparantly Germany's business community is not in the 'Europe is insolvent' camp.

Overall the survey shows that growth is continuing to move forward. Businesses appear to be embarking on capital spending that should sustain growth until the consumer confidence and spending resumes.