A week ago, we accumulated enough evidence to conclude that the U.S. economy is most probably headed into a second leg of recession. It is unclear whether this will be identified as a second recession or a continuation of an existing downturn. In either case, I've repeatedly noted that the apparent strength in the U.S. economy over the past year has been driven almost exclusively by an almost inconceivably large burst of fiscal and monetary "stimulus" last year, whereas intrinsic economic activity has stagnated. Personal income remains at its lows once government transfer payments are excluded, which is in stark contrast to typical post-war recoveries. Weekly jobless claims are pushing again toward 500,000, whereas prior post-war recoveries have seen jobless claims quickly retreat below the 400,000 figure that roughly delineates job growth from continued job losses. The most straightforward explanation of the economic data is that we've observed a stimulus-led recovery that has not translated into private economic activity, and that the effects of the stimulus are now diminishing.
My most urgent concern over the past few months has been directed toward investors with spending plans (tuition, home purchase, baby, medical, retirement) that rely on the near-term availability of funds. If you are following a disciplined investment strategy, your portfolio is well-diversified, and you are tolerant enough of risk that the declines in 2000-2002 and 2008-2009 did not materially derail your investment discipline, then please, ignore my views and the views of everyone else and just follow your discipline.
My concern is for individuals who will need the money within a small number of years and yet are invested as if they are long-term investors, not in adherence to a specific discipline, but simply because the market was, until recently, advancing. Too many people got their life plans derailed when the tech bubble crashed, and when the credit crisis hit. If a major market loss would derail your life plans, you're taking too much risk here. That said, I have no intent to cheerlead for the bears. In our most defensive stance, the Hussman Funds may be fully hedged, but we do not take net short positions and we don't "bet" on the market to decline.
Over the short and intermediate-term, credit crises are invariably deflationary, because they prompt a frantic demand for default-free government paper, which raises its value relative to goods and services (another phrase for deflation). So despite the huge increase in government obligations during these periods, you generally don't see inflationary pressures in the early years because that supply is eagerly absorbed. Short-term interest rates are pressed near zero, and monetary velocity tends to collapse. Commodities are usually hard hit as well, so investors who are concerned about inflation risk or are chasing gold here may have the long-term story right, but they probably have it too early to weather the interim volatility comfortably.
Over the long-term, massive increases in government liabilities do have inflationary impact. This imposes a real burden, not simply a paper one. If the holder of government currency can command a certain stock of real goods and services, and then the government debases that currency so that it can command a lesser stock of real output, then it is undeniable that the difference in real value has been implicitly transferred to the government to finance its spending. While I do expect that TIPS, commodity exposure and precious metals will be important inflation hedges in the years ahead, investors chasing these assets here may have a difficult road. It is best to accumulate such assets when they are in liquidation, not when they are being chased on the basis of overly simplistic theories of inflation.