Found via Market Folly.
Headlines related to unemployment and pending stimulus expirations have unnerved investors this quarter. As a consequence, equity markets proved volatile with fears that the recovery has been held together by government fiscal and monetary stimulus and when removed the economy will once again spiral into a deep recession. While we have considered this outcome, the weight of the evidence continues to point to a more inflationary scenario. Binary outcomes, such as this, can often be solved through analyzing the source of the greatest incentives.
When Charlie Munger spoke about the Psychology of Human Misjudgment to Harvard Law School students he stated “I think I have been in the top 5% of my age cohort all my life in understanding the power of incentives, and all my life I’ve underestimated it.” We conclude that it is not economically or politically feasible to do anything but print money. A “do not fight the Fed” mantra is very instructive right now and it could even be expanded to “do not fight a Fed backed into a corner with no way out.” The Fed’s incentives lie squarely on preventing further job losses, leading this administration into the best chances of re-election, and resetting the bar through debt debasement of post credit bubble developed world liabilities.
We believe that the Fed’s planned wealth effect is truly a wealth illusion effect. While asset prices may climb they will only rise alongside inflation. Printing money moves in a direction of solving the critical incentives that are “front of mind” with central banks. We do not see a strong incentive bias to the contrary that would lead us to believe we are going down a path of austerity measures. In this regard we have been and continue to operate with extreme care in protecting the purchasing power of our clients’ wealth. Accumulated wealth is at greater risk of purchasing power loss than the principal loss of owning a high-quality, competitively entrenched, reasonably priced businesses.
Portfolio construction continues to be a balancing act. Weekly, we ask where the consensus is today and observe that most do not share our viewpoint. Winning by not losing in a world of heightened inflation is a completely different paradigm for investors with thirty years of reinforced biases to the contrary.