We have an ongoing commentary in this blog on the inflation/deflation debate.  It’s widely believed that the Fed’s expansion of the monetary base in 2008 and 2009 will eventually spark inflation — or worse, hyperinflation.  Long-time readers know that we do not consider this a likely outcome.  To start, credit continues to be destroyed in the private sector faster than it can be created by the Fed.  Lending standards remain ridiculously tight — just ask anyone who has recently purchased a home.  And the velocity of money remains deeply depressed.

On top of these factors, the Fed has publicly outlined its game plan for “soaking up” the excess liquidity it created during the meltdown.  Essentially, the Fed is going to pay banks to keep their funds on deposit with the Fed in instruments resembling the certificates of deposits (CDs) sold by banks to retail customers.  The idea behind this “Term Deposit Facility” is that by controlling the rate of interest that the Fed pays on deposits, the amount of new credit creating in the real economy can be controlled.

It will be an interesting experiment. And it IS an experiment, as the Fed is currently in uncharted waters in its implementation of monetary policy.   We shall see, but to me this looks like yet another reason to believe that inflation will not be a significant problem going forward.

Charles Sizemore, CFA
Co-author of the recently-published Boom or Bust: Understanding and Profiting from a Changing Consumer Economy

 The manager of one of the biggest and most successful inflation-protected bond funds does not see inflation; he sees deflation.

If there was ever an investor that had every incentive to forecast inflation, it would be Mihir Worah, the manager of the Pimco Real Return Fund and the largest holder of inflation-protected bonds in the world.  As the expression goes, when the only tool you have is a hammer, everything looks like a nail.  Worah’s investment mandate is to protect his investors from inflation, so following the analogy, he should see inflation nails that need hammering around every corner.

But, as Bloomberg reported this morning,

Pimco is “underweight” inflation-linked bonds in portfolios that focus on the debt, Worah wrote in a report on Pimco’s Web site….  “There is a near-term risk of flipping to deflation given our view that developed economies have not fully healed and consumers are not yet ready to stand on their own two feet,” wrote Worah, a managing director based at Pimco’s Newport Beach, California, headquarters.

Worah echoes BlackRock Inc., the world’s biggest money manager with $3.35 trillion in assets, which said it is becoming bullish on Treasuries because “there isn’t inflation in the pipeline.” See article.

We’re starting to see some intelligent minds move to our camp in the inflation/deflation debate.  Our view remains clear — there IS no inflation right now.  We continue to see mild, Japan-style deflation as the most likely outcome of the credit crisis and deleveraging.

Charles Sizemore, CFA
Co-author of the recently-published Boom or Bust: Understanding and Profiting from a Changing Consumer Economy

Tech Ticker had some great commentary that corroborates our view of continued deleveraging and deflation:

In case you can’t see the embedded video, follow this link: The Fed’s “Exit Plan” Is Just Another Secret Gift To Wall Street.

As Henry Blodget explains it, the Fed is in a bind.  The extraordinary monetary stimulus used during the crisis cannot be continued indefinitely without damaging the long-term credibility of the US dollar.  But at the same time, the Fed cannot shrink its balance sheet by selling off its vast portfolio of mortgage-related debt without causing mortgage rates to rise, further damaging a weak housing market.So what are they proposing to do?  Pay the banks not to lend! Read the rest of this entry »

Nearly a year ago, we first commented that professional sports were getting slammed by the recession (see “Bailout Culture Spreads…to Basketball?” and “Now the Recession Has Hit the NFL“)

This isn’t a garden-variety recession we are experiencing.  It’s something bigger this time; a psychological tipping point has been reached.  The mid-to-late 2000s witnessed the gentrification of professional sports.  Beer and hot dogs were replaced with saki and sushi…or Starbucks!  And perhaps nothing symbolized the excesses of the era more than the Dallas Cowboys and their billion-dollar stadium (subsidized by Arlington taxpayers, of course).  But today, a little more than a year after the financial meltdown, these excesses appear more and more to be a high-water mark of sorts.   Team owners seemed to have forgotten that most sports fans are not the champagne and caviar crowd; they are  far more likely to be found with beer and pretzels…and that’s regular domestic beer, not the microbrew or imported stuff.

So, after the building spree of the past 15 years, we find ourselves with overcapacity in professional sports.  Expensive overcapacity.  We also find ourselves with sagging demand: “NBA ticket revenue slides 7.4 percent”

CBS Sports writes,

Average paid attendance is down 3.7 percent in the NBA through the first quarter of the regular season, sending gate receipts plummeting 7.4 percent, according to league documents obtained by CBSSports.com.

Net gate receipts, the money teams make from ticket sales, fell to an average of $828,985 per game, down from $894,823 at the same point last season. Only nine teams were up or flat in average net gate receipts through Nov. 29, while 21 teams saw a decline.

Excess supply and tepid demand can only mean one thing — falling prices.  Could it be that the bubble in professional sports — including everything from ticket prices to player salaries — could be giving way to deflation?  2010 is supposed to be an enormous year for NBA free agency; if current trends continue, there might be a lot of disappointed free agents.

Charles Sizemore, CFA

Co-author of the recently-published Boom or Bust: Understanding and Profiting from a Changing Consumer Economy

“The Law of Disruption,” writes Larry Downes in his new book, “is a simple but unavoidable principle of modern life: technology changes exponentially, but social, economic, and legal systems change incrementally.” (see “The Laws of Disruption: Harnessing the New Forces that Govern Life and Business in the Digital Age”)

Mr. Downes has written a book that is both a history of the information economy and a sweeping call to arms to implement legal reforms to better reflect modern realities. In the coming HS Dent Forecast, we’re going to take a look at some of Mr. Downes’s suggestions, including his proposed overhauls of the copyright and patent systems, which— in Mr. Downes’s opinion — were created for a different age and a very different kind of economy. But today, we’re going to take a look at the three principles—Moore’s Law, Metcalfe’s Law, and the Law of Disruption— that Mr. Downes uses to create a “grand unifying theory” of sorts for the digital economy. Read the rest of this entry »

Barry Ritholtz posted a link to this excellent piece by Bloomberg’s Alice Schroeder on bubbles throughout history: “Gold Tells You US Bubble Hasn’t Popped Yet.”

Echoing our thoughts on gold from last week, Ms. Schroeder writes:

I’ve never been a gold bug myself. They get no respect. They are associated with survivalists, conspiracy theorists and nutcases. They are always looking for the hyperinflation that never comes. Gold bugs pay a premium over the metal price for gold and silver coins on the notion that they will need the currency, come the Apocalypse.

Ms. Schroder does give the gold bugs credit on one count, however. While gold has had a mixed history as an inflation hedge, it has offered insurance-like protection from currency crises. Fair enough. But buying gold today to protect against a dollar crash seems a little like closing the barn door after the horses are already out. The dollar has already been in a grinding bear market for nearly a decade. Is now the time to buy insurance? Or, to use another analogy, is there much of a point in buying storm insurance after the hurricane has already hit your house?  Or buying life insurance after you’ve been hit by a bus?

Only time will tell, of course. And gold could very well soar higher from its current levels. This is the nature of bubbles. But we should be clear that at current levels, gold is in a bubble, and monies allocated to gold should be viewed as highly speculative.

Deflation continues to be the real threat. Read the rest of this entry »

Gary Shilling gave an interview with Yahoo! Tech Ticker in which he lays out a scenario very similar to that of HS Dent:







Mr. Shilling is taking a hard contrarian view here. It’s accepted as near “gospel truth” that inflation — BIG inflation — is coming down the pipeline. But where is the proof? Yes, the monetary base has expanded. But what of it? Banks, businesses and consumers all continue to deleverage. Money is being destroyed faster than it can be created. And prices, outside of volatile items like food and fuel, continue to show mild signs of deflation. We suspect that those investors currently piling into gold when it is sitting at all-time highs will soon be sorely disappointed when hyperinflation fails to appear.

Charles Sizemore, CFA

Co-author of the recently-published Boom or Bust: Understanding and Profiting from a Changing Consumer Economy

Hedge fund manager David Einhorn had some interesting comments on the dollar in the recent Value Investing Congress:

When I watch Chairman Bernanke, Secretary Geithner and Mr. Summers on TV, read speeches written by the Fed Governors, observe the “stimulus” black hole, and think about our short-termism and lack of fiscal discipline and political will, my instinct is to want to short the dollar. But then I look at the other major currencies. The Euro, the Yen, and the British Pound might be worse.  So, I conclude that picking one these currencies is like choosing my favorite dental procedure.

This more or less sums up our view at HS Dent.  We agree that the dollar is a horribly mismanaged currency by an irresponsible and self-destructive government.  The problem is…so is every other major world currency!  It’s difficult to make money shorting the dollar when there is no viable option to short against.

Einhorn reaches the conclusion that, since all paper currencies appear to be in a race to the bottom, gold is the direction to go.  We’d tend to disagree with Mr. Einhorn on this count because we believe gold will face some serious headwinds in a deflationary environment — and the bond market is still telling us, in contradiction to the gold market, that deflation is the real concern.

The dollar is a despised asset right now — it is nearly impossible to find anyone who is bullish on the dollar.  This could make the dollar an intriguing contrarian investment.

Should  the stock market roll over in a new bout of risk aversion, the dollar should rally sharply.  But even if risk aversion remains benign, we would expect the dollar’s current weakness to reverse at least marginally in the next year.  Its current depressed value against the euro would appear to be unjustifiable given the economic challenges that the eurozone faces.

Charles Sizemore, CFA
Co-author of the recently-published Boom or Bust: Understanding and Profiting from a Changing Consumer Economy

We’ve written about the Amazon Kindle in prior posts, specifically on it power as a disruptive technology to revolutionize the centuries-old industry of book publishing.  (We use the Amazon Kindle by name by personal choice, but competing e-book readers such as Sony’s are certainly part of the revolution too.)

Now, we read in the New York Times that the revolution is coming to the public library (see “Off the Shelf, Onto the Laptop, Libraries Turn to Digital Books“).

Thus far, libraries have barely gotten their feet wet.  But the changing economics of the industry make us believe that e-books will quickly become a large percentage of new purchases.  In explaining the model, the Times writes,

Most digital books in libraries are treated like printed ones: only one borrower can check out an e-book at a time, and for popular titles, patrons must wait in line just as they do for physical books. After two to three weeks, the e-book automatically expires from a reader’s account.Some librarians suggest that because digital books never wear out, take up no shelf space and could, in theory, be read by multiple people at the same time, the purchasing model for e-books should be different than it is for print…

But some publishers worry that the convenience of borrowing books electronically could ultimately cut into sales of print editions.

Publishers are right to worry.  They saw what happened to the music recording industry, and they shudder to think that it can happen to them too.  But like it or not, it will happen, in some form or another.

The competitive forces of capitalism — made all the sharper by the deepest and longest recession since the Great Depression — will continually lower prices for consumers when not restricted.   The delivery of intellectual property via electronic means — be it software, music, or a book — is virtually free, as is reproduction of the material.  It’s also “greener” and better for the environment, requiring less physical plant, storage space, and fuel.  The price savings here represent “good deflation,” the innovation-driven kind that makes our society as a whole richer.  (This is not to be confused with “bad deflation,” which is due to falling final demand.)

Piracy is a problem, but not an insurmountable one.  Microsoft manages to remain profitable despite widespread piracy of its software, and it mitigates this with product keys.  Apple experimented with digital rights management to avoid MP3 piracy, though this has been less successful.

Authors, like musicians, may have to find a new business model.  Perhaps they could generate revenues through consulting services the same way that musicians do concert tours?  It’s hard to say exactly how this will all play out.  Authors (alas, ourselves included) may find book publishing less lucrative in the future, though we believe most of the pain will be felt not by the authors but by the middlemen that are increasingly becoming obsolete.

It’s hard to know what direction the industry will go and who will be left standing once the dust settles.  But that is the beauty of a revolution — it will be fun to watch!

Charles Sizemore, CFA
Co-author of the recently-published Boom or Bust: Understanding and Profiting from a Changing Consumer Economy

We don’t buy into conspiracy theories that the government intentionally distorts economic data as part of some kind of diabolical scheme to fleece the voting public.  These allegations pop up routinely, usually (though not always) in off-beat investment newsletters, and are particularly focused on the reported stats for inflation and unemployment.  (Somehow, using a core inflation gauge that excludes volatile items like food and fuel or using hedonic adjustments to account for technological improvements are forms of government chicanery…)

At any rate, while the numbers may not be lies or intentional distortions, this does not imply that they are complete or that they tell the whole story.  Read the rest of this entry »