Asset Melt Down & Melt Up
First asset deflation, then price inflation. How to defend wealth amid the "melt up"...?
SO HOW ABOUT that...? asks Dan Denning in his Daily Reckoning Australia.
For two days running after land-mark healthcare legislation passed the US Congress, stocks in New York made a new 17-month high. The market likes it when uncertainty is lifted from the horizon. It's now clearly all down-hill from here.
We jest. Back in Baltimore earlier this month, at dinner, it was argued by one and all that stocks might be a good bet to beat inflation. Or, put another way, if you're going to beat inflation, you're more likely to beat it in stocks than cash.
This is not a value-based argument. But it IS an argument for why nominal gains in stock markets are not inconsistent with rampant or even hyper inflation. We're not saying that's what's going on right now. And of course, in our one-two Big Crash dance card, asset deflation precedes the Melt Up.
But it's hard to call the rally since last March's lows anything else but a melt-up. Stocks aren't cheap now. And they are pricing in a lot of future earnings growth. In a world where the private sector and businesses are deleveraging and where credit growth – excepting the public sector – is shrinking, the fuel that generates earnings and income growth is running out.
Not that sovereign bonds are any safer. Another point that came up at our dinner earlier this month is that certain high-quality corporate bonds would be better bets than certain faltering sovereign bonds. Or as Bloomberg reports, "The bond market is saying that it's safer to lend to Warren Buffett than to Barack Obama."
If you judge executives by their ability to deliver regular and outstanding returns on equity and capital, the above point is self evident. Buffett has a long track record of delivering high returns on net tangible assets. This partly explains why the yield on two-year notes sold by Berkshire is 3.5 basis points lower than the yield on a two-year US Treasury note.
Buffett generates cash from his assets and borrows sparingly for sensible acquisitions of good businesses which he has meticulously valued (most of the time). The Federal Government is not a corporation. But its chief asset is probably its tax slaves, whom it is currently in the process of flogging for more money to pay for more new programs which the country can't afford.
The trouble is, as Moody's points out, when you flog your tax slaves in order to simply pay interest on money you've already borrowed, you move "substantially closer" to losing your AAA credit rating. Moody's predicts that, "the US will spend more on debt service as a percentage of revenue this year than any other top-rated country except the U.K. America will use about 7 percent of taxes for debt payments in 2010 and almost 11 percent in 2013."
Does this mean short-term capital flows – as Greece plays out in slow motion – will favour Dollar-denominated assets that are:
- not long-term government bonds; or
- are stocks...?
We'll see. But when US investors get nervous and flee home to the US Dollar, what happens then? And when US and UK banks get into capital self-preservation mode, doesn't that leave Australia in the vulnerable position of being a capital importer in a world where the cost of capital is going up?
For now, the whole thing makes us nervous. And if the bulls are happy to rush in where nervous angels fear to tread, more power to them. And let's not forget the elephant in the room: property.
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