We've Only Just Begun? Contrary Investor - February 2009

[slipslidingaway]

http://www.contraryinvestor.com/mo.htm


"We’ve Only Just Begun?…Yeah, that’s pretty much how we see it at this point. We’re referring to the process that is macro or systemic deleveraging. It was way back in April of 2007 that we penned a discussion entitled, “It’s Delightful, It’s Delovely, It’s Deleverage”. At that time very few folks were talking about deleveraging as a concept and economic force to come. Fast forward to the present and it’s now consensus thinking. Although the theme has been very much popularized in the mainstream press, we see very little attention to specific detail. So, in that spirit, this discussion is all about a check in on the concept and detail as to where we now stand. Nothing like the facts to illuminate the true picture, no?

To the point, deleveraging is not an event, but a process. As we've explained in the past, the multi-decade credit cycle phenomenon was key to economic and financial market outcomes in the US, as well as globally for close to three decades. The whole concept of deleveraging dramatically interrupts, or really derails that cycle. Coincidentally, the Fed/Treasury/Administration are in do or die reflation mode at present. Reflation really meaning an attempt to restart what is a critically wounded credit cycle. Mortally wounded? We’re going to find out. In this light, monitoring the process that is deleveraging becomes very meaningful in terms of trying to interpret just what the financial markets are pricing in at any point in time. We believe it's also helpful in terms of trying to monitor the economic slowdown magnitude and duration issues so key to near term investment outcomes....


...In summation, debt growth throughout the broad US economy, exclusive of the asset backed securities markets (that is in clear deleveraging mode) and the Federal government (that is in clear leverage acceleration mode), has only slowed, but not gone into net contraction. As per the nearer term directional trends seen in the charts above, it appears households and the non-financial corporate sector are either in or will enter the process of net leverage contraction (deleveraging) very soon. Consumption, production and price deflation trends in a number of asset classes (primarily residential real estate and equities) has occurred up to this point against a backdrop of only slowing household and corporate debt growth. Just what will happen if/when household and non-financial corporate leverage begins to actually contract in nominal terms? THAT’s the key question for us as investors over the quarters directly ahead. The markets have priced in sector implosion (financial sector) and the potential for a recession of a mid-1970’s/early 1980’s magnitude. But, the broad deleveraging process has really just begun. We have a very hard time seeing this process truncated in the quarters ahead. The potential clearly exists for a multi-year reconciliation process. Have the markets already priced in a multi-year deleveraging process, with specific emphasis and implications as per consumers? That we do not believe has happened, except maybe in the Treasury market. You already know we will be monitoring and discussing these very issues as we move forward. Deleveraging is not done. As you can see, it has barely begun...


...Hopefully expressed in simple terms, the prior period credit cycle was a massive anomaly. That anomaly raised US nominal GDP, corporate profits and asset values to levels they never would have experienced in the absence of maniacal credit creation. Now that the meaningful deleveraging process we have been ranting and raving about is evidenced all around us and is really still in its infancy, we believe the US economy, corporate profits and asset values are in the process of shifting downward to a “new normal”. THIS is what the current equity bear market is all about. Corporations are adjusting to this new normal by cutting costs as their revenues shift downward. Households are adjusting to this by massively lowering their intake of leverage, and we believe soon to be paying it down. Even Ballmer recognizes the anomaly is over and is acting appropriately as far as Microsoft is concerned. When will this most important of messages and conceptual thinking make it to Washington? Answer: Don’t hold your breath, okay? After all, everything we've seen from the powers that be so far suggests to us they have absolutely no intention of adjusting to a new normal, but rather are doing everything in their power to recreate the old anomaly.

[dixiegrrrrl]

1. That last sentence is key....horribly so.

"everything we've seen from the powers that be so far suggests to us they have absolutely no intention of adjusting to a new normal, but rather are doing everything in their power to recreate the old anomaly."

Washington wants to remain in denial of a basic law...what goes up must come down.
And the economic rise this time was based on unsustainable debt.

[slipslidingaway]

2. True...after the tech bubble burst our country should have made

some major adjustments, instead the we were told to borrow and shop.

[chill_wind]

3. Wish I could still rec, but I can kick.

[slipslidingaway]

4. Thanks for that kick...

they do some great charts and dig into the numbers ahead of time.

I remember reading the monthly article below back in August 2007, I had already noted the divergences in the broader equity market charts with the McClellan Oscilator & Summation charts, so it was another reason to be careful of retirement funds invested in the stock market.

Explanation of McClellan charts...
http://www.democraticunderground.com/discuss/duboard.php?az=show_mesg&forum=327&topic_id=716&mesg_id=716


http://www.contraryinvestor.com/2007archives/moaug07.htm

August 2007

"...As we promised, trying to keep it short, there you have it. Although we believe each individual chart tells its own story, our main point in this discussion is that collectively, these relationships represent multi-year or multi-decade trend breaks for now. They are now occurring in simultaneous fashion. Just a coincidence? We think not. Moreover, we suggest an important need for continual monitoring as these trends quite similarly hug trends in powerful demographic changes. Could it really be that as the boomers push near and into retirement, what has been their dramatic impact on asset inflation through continual expansion in household leverage is changing? We believe this is indeed the primary question and message to continue to monitor in these relationships. As we’ve suggested many a time, the credit cycle is the key. And this is a slice of the broader credit cycle as it applies to households. Households key to longer-term consumption trends important to both the US domestic and many a foreign exporting economy. You know we’ll be checking back in on a quarterly basis to monitor whether these initial trend changes remain intact, or are simply blips on the ever-growing leverage expansion screen."


Edited to make more sense.

[slipslidingaway]

5. Recession? No, It's a D-process, and It Will Be Long

http://online.barrons.com/article/SB123396545910358867.html


"Dalio: Let's call it a "D-process," which is different than a recession, and the only reason that people really don't understand this process is because it happens rarely. Everybody should, at this point, try to understand the depression process by reading about the Great Depression or the Latin American debt crisis or the Japanese experience so that it becomes part of their frame of reference. Most people didn't live through any of those experiences, and what they have gotten used to is the recession dynamic, and so they are quick to presume the recession dynamic. It is very clear to me that we are in a D-process.

Why are you hesitant to emphasize either the words depression or deflation? Why call it a D-process?

Both of those words have connotations associated with them that can confuse the fact that it is a process that people should try to understand.

You can describe a recession as an economic retraction which occurs when the Federal Reserve tightens monetary policy normally to fight inflation. The cycle continues until the economy weakens enough to bring down the inflation rate, at which time the Federal Reserve eases monetary policy and produces an expansion. We can make it more complicated, but that is a basic simple description of what recessions are and what we have experienced through the post-World War II period. What you also need is a comparable understanding of what a D-process is and why it is different..."