Sunday, September 25, 2011

Inducing a Recession, Opportunities?

Reading the general and financial media, be it print or on a screen, most of us see disappointment. In part because of our disappointments with political leaders around the world, we are taking away their firepower by inducing a recession. We are disappointed with the various politicians for their reluctance to solve the growing gulf between what we want to receive as a society, and what we are willing to pay for in the way of taxes and fees. Since political leaders wish to get elected, they are reluctant to force the narrowing of this gap.

As political leaders like spending as much as getting elected, we are pressing them to cut expenses, mostly by cutting the other person’s entitlements or benefits. This less spending without an offsetting increase in the private sector will shrink the size of the global economy. Since the expected general level of demand will be reduced thus creating a recession, many are already cutting back on expenditures and have a pessimistic attitude toward investment obligations to themselves and others.

Two extreme behaviors

The first extreme behavior assumes the worst is compounded into tragic levels. Since politicians won’t lead, in this scenario we will see the equivalent of the “Man on Horseback” taking charge and forcing a solution, usually by attacking one or more groups. The dastardly actions of various dictators of the 1930s who “solved” the crushing debts of their country are the source of some people’s paranoia. Following historical precedents, the group to be attacked are the wealthy people, who fear a pillaging of their assets. This fear is palpable today for some. In an investment group meeting last week, we were informed by a third generation dealer in gold bars and coins that sales of these items for personal delivery are skyrocketing. The announced intended purpose for this portable wealth is to pay bribes to cross a border. For some, this was experienced during their lives or their parents' lives in Europe and Asia. Others feel that their wealth is threatened by various left leaning governments, including the present gang in Washington. Their demand for physicals is such that new vaults specifically designed to hold gold, and to some degree silver, are being sold in London and elsewhere. Perhaps another example of this conversion of fiat currencies is that the highest priced real estate properties are selling very well.

The second extreme behavior is that some are buying in the face of plunging stock prices around the world. The buyers could well be traders who recognize, using the past metrics, that both the S&P 500 and the MSCI EAFE are oversold by a significant amount, at least as of Thursday’s close. The other possibility is that the buyers are really investors who know something. My brother points out that our grandfather, based on decades of Wall Street experience, told us that the person on the other side of a trade may know as much, if not more, than we do.

Asian Lessons

Perhaps the rumored flirtation of the Chinese for Italian debt was aborted by their analysis that the rating agencies would lower the credit rating on both the sovereign debt and two of the largest banks in Italy, which occurred last week. A more difficult factor to consider is the announcement last week that FedEx is significantly lowering its estimate of the growth in revenues of expected parcel traffic from Asia for the rest of the year. What requires more study is whether the projected drop in growth is due to an expected dip in the sales of Christmas items in the US. Historically, we have thought of Asia primarily as exporters to the US and Europe. However, our Asian portfolio managers point out that over half of Asian exports are now done within Asia. If the expected decline in the growth of air freight shipments is due to an expected weakness in the Christmas trade, that fits with the induced recession scenario. If on the other hand, the growth of consumer demand within Asia is softening, this could be much more serious. The continued growth in Asian consumer demand is critical to my long term investment philosophy, and to others as well.

What is happening in the “Real World?”

According to a survey done by JP Morgan Chase, 75% of small company CEOs are planning to add people in the coming six months. They may feel that they have a chance to fill a void left by their larger competitors who are pulling back. What appeals to me is that there is an abundance of high quality talent available, either already separated from their employers, or people who are available for the first time.

What should Investors Do Now?

We are reducing our fixed income exposure for our long term accounts who perceive that they have extended obligations to various beneficiaries. Soon the only high quality fixed income that we intend to own will have short maturities. Periodic, planned increases in equities make sense for many of our institutional and High Net Worth clients.

What are you doing with your portfolios?
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