A new age of uncertainty
PORTFOLIO POINT: Analysts are divided as to whether deflation or hyper-inflation will define the global environment in the years ahead, but prudent investors can prepare for both outcomes.
Here are two diametrically opposed views on the future for investors.
Harry Dent, the author of the best-selling book The Great Crash Ahead (published 2011), says the developed world is undergoing deflation because of demographics and deleveraging. In his view, the only reason that the global sharemarket recovered after March 2009 was a combination of fiscal stimulus packages and central bank money-printing.
According to Dent, over-indebted governments will be reluctant to keep pump-priming the private sector since there is nothing that can be done to reverse its contraction. As for central banks, their balance sheets are too small to offset private sector deleveraging once it starts in earnest. The debt deflation that has started will be on a much greater scale than occurred in the 1930s.
Dent says that unwinding private debt is only part of the problem. On his reckoning, household spending, which makes up two-thirds of the economy, is set to fall until 2023 because the baby boom generation is moving from peak earnings (with conspicuous consumption) to squirreling away for retirement (by making saving the new spending). Furthermore, retirees spend less on everything except health and aged care.
When heads of households reach 46 to 50 years of age, their spending peaks, as can be seen in the next chart. Thereafter, spending plummets sharply and history shows there is nothing governments can do to stop that.
Because the age structure of the population and immigrants is known, one can calculate with some certainty the number of people who will reach 46 in each of the next 45 years.
According to Dent, the stockmarket broadly moves in step with the number of 46 year olds who are a proxy for peak spenders (see next chart). This is why, prior to the GFC, Dent forecast a 16-year secular bear market starting around 2008. The next primary bear market he now believes will start in early 2012.
In Dent’s view, secular bull markets are driven by a social shift from young to early middle-aged families (as happened in the 1980s and 90s), while secular bear markets are caused by a population shift to late middle-aged families and retirement. The next secular bull market won’t start until 2023, when the echo-boom generation moves into early middle age.
The contrary viewpoint is held by cyclical market analyst Larry Edelson. He asserts that voters won’t tolerate governments and central banks closing their wallets while the community is forced to deleverage and rebuild savings. Edelson points to the backlash to official austerity measures in Europe as reflected in recent French and Greek elections, and the collapse of the Dutch government. He believes that it’s only a matter of time before central banks resort to the printing presses again to buoy asset prices.
In his view, politics will force governments to adopt the easiest route to diminishing debt, which is by monetising it (i.e. inflating home, share and other asset prices by flooding the economy with money). If debt stands still while asset values rise, net debt falls. That’s why central banks printed $US4 trillion of new money in the last four years. The ultimate losers in such a scenario are cash, term deposit and bond holders.
Edelson thinks central banks will print another $US16 trillion before a tipping point is reached by inflation getting out of control. He says:
There’s no question in my mind that another inflationary surge is right around the corner. And it will be a big one, the biggest yet.
While no one can accurately nail down when the next inflation surge will begin, all of my indicators tell me that we should see it by no later than September.
The sector that will respond almost immediately will be none other than the same sector that responded the most in the earlier wave of rising inflation: commodities, tangible assets, natural resources. We’re not there yet, but we’re getting close.
I believe that the next phase of the greatest natural resource bull-market in history is about to begin. It will be borne on the back of collapsing governments ... massive central bank money printing ... and a stampede by savvy investors everywhere to protect and grow their money with tangible assets.1
If Edelson is right about resources, then Australia will be in the front seat. In any event, our sharemarket would boom on the back of such a global money explosion.
At MarketTiming, I don’t know whether the combined forces of deleveraging and demographics will usher in a decade of deflation, as forecast by Dent, or whether central banks will try to stop this by showering the world with new banknotes, as predicted by Edelson.
What the deflationary experience of Japan since 1990 shows, however, is that those who timed its sharemarket using trend-following principles made good money by riding upswings and avoiding downswings, notwithstanding that the market fell by 80% from peak to trough.
Japan’s Deflation 1990-2012 (Nikkei Share Index)
Brazil’s hyper-inflationary episode, from 1980 to 1993, saw its stockmarket post an average annual return of 240% in local currency and 36% in US dollars, even though its credit rating was poor. Argentina had a parallel experience.
So what are we about to experience – Dent’s deflation or Edelson’s hyper-inflation?
One answer is to be sanguine about the future (like the Commonwealth Treasury, the Reserve Bank and most economists) and presume the global financial crisis will keep bypassing Australia.
A more prudent approach is to prepare for any eventuality by keeping a balanced investment portfolio and timing the share component using trend-following principles. Anything else, in our view, is a high-wire act without a safety net.
(1. Selected quotes from The Next Inflation Surge and The Profit Opportunity of the Century, Uncommon Wisdom newsletters, May 7th and 13th, 2012.)
Percy Allan AM is chairman of MarketTiming.com.au. For a three-week free trial of its services, click here.