Monday, December 7, 2009

Hussman Weekly Market Comment: Credit Crises Generally Require Multi-Year Adjustments

There are some good graphs and quotes from Ken Rogoff and Carmen Reinhart’s book in the latest Hussman piece linked below. Some things in this piece reminded me of something Howard Marks wrote in his memo entitled The Long View: “In my opinion, there are two key concepts that investors must master: value and cycles.” As you may have noticed, I’ve posted more things this year on the blog that relate to the cycle side of investing than I have in the past – and much of that has to do with the insight in that quote from Mr. Marks, along with some holes I noticed in my own philosophy as things unfolded during the current financial/credit crisis.

Aside from the likelihood of further credit losses, my primary macroeconomic concern at present is the likelihood of far larger deficits and eventually, inflation, than investors appear to anticipate. As I've noted before, the inflation issue is most likely several years out, because over the shorter run, fresh credit difficulties are likely to boost “safe haven” demand for default-free U.S. government liabilities, which will allow the huge new float of these liabilities to be absorbed without an immediate deterioration in their value. From a longer-term perspective, particularly after we work through the adjustments of the next two or three years, it appears very unlikely that the enormous collapse in “monetary velocity” that we've seen during this crisis will be sustained. Over time, the increased supply of U.S. government liabilities (whether in the form of monetary base or Treasury securities) is likely to be met by a similar depreciation in their value. I continue to expect that we will observe an approximate doubling of the U.S. consumer price index over the next decade.

Reviewing some recent comments from Rogoff (who used to be head of the International Monetary Fund) and Reinhart, it's notable that they share these same concerns:

“Assuming the U.S. continues going down the tracks of past financial crises, perhaps the scariest prospect is the likely evolution of public debt, which tends to soar in the aftermath of a crisis. A base-line forecast, using the benchmark of recent past crises, suggests that U.S. national debt will rise by $8.5 trillion over the next three years. Debt rises for a variety of reasons, including bailout costs and fiscal stimulus. But the No. 1 factor is the collapse in tax revenues that inevitably accompanies a deep recession. Financial crises don't last forever. But this one could last a lot longer if policymakers don't start basing their actions on more realistic assessments of where we are and what is likely still to come.”

“The marketplace is suggesting that there's not going to be a lot of inflation in the near term. During the height of the crisis the alternatives to dollar assets were not there. It wasn't irrational, but it was lack of alternatives. What concerns me most about inflation is not something that is imminent. The inflation question becomes more pressing in a 5-10 year time horizon—and it's not 5 years from now, it's 5 years from where the crisis started, which was two years ago. If we had a history of defaults, like in South America, that horizon would be compressed. For other cases, you have more time.”