Power point by: Michael Frasier. Going through hardships can make a person stronger.
the Case for Going Global is Stronger Than Eve
Transcript of the Case for Going Global is Stronger Than Eve
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TheCaseforGoingGlobalIsStrongerThanEver
TheUSMarketsAreStillInTrouble
UndercapitalizationMakesEmergingEconomiesMoreEfficient&DevelopedEconomiesLess
Efficient
EmergingMarketsStillUndervalued
GlobalCapitalShiftIsAcceleratingTheBiggestGrowthWillBeintheMostObviousPlaces(andSectors)
ConventionalDiversificationWon’tCutItAnyLonger
Risks(andthereareplenty)
MaineandQE3,OperationTwist,etc.?
ByJohnMauldin
August5,2011
Aswillbeclearbelow,Ihadfinishedanearlierversionofthisweek’se-letter,butthe
eventsofthelastfewminutesrequireafewparagraphs.AsIwriteattheendoftheletter,
BloombergkepttheirsatellitetruckhereinMaine,astheyhadgotadvancewarningofthe
downgradebyS&PofUSdebtandwantedtointerviewanumberoftheeconomistshere,
includingyourhumbleanalyst.Ican’trewritetheletteratthislatehour,butwillsendyou
additionalcommentsonMonday.Andyoucangotowww.bloomberg.comandseeeveryone’s
remarks,includingmine.Itwillbetheresomewhere,theypromiseme.
Andnow,afewquestionsandobservationsareinorder.
First,asIwalkedtotheareawheretheBloombergwasshootingtogoon,JimBianco
andJohnSilviatoldmethatS&PhaddowngradedtheFed.Ilaughedandsaid,“Ifyouguyswant
tomakemelooklikeafoolonTV,youhavetoatleastmakeupacrediblelie.”Theykeptinsistingitwastrue.IfinallyaskedMikeMcKeeofBloombergandBarryRitholtz,whowason-
air,ifitwastrue.Theyclaimeditwas,too.Iwasstillwonderingiftheyweresettingmeup,but
evenRoubini(whowouldn’tdothattome)saiditwastrue.
So,iftheFed,whichdoesn’tissuecreditandcanprintmoney,canbedowngraded
becauseitholdsAA+debt,thenwhyandhowinhellcantheECB,whichholdshundredsof
billionsofeurosofthejunkdebtofGreeceandIrelandandinsolventbanksnotbedowngraded
onMonday?AndtheBankofJapan?REALLY?Whataretheseguyssmoking?Dowenow
downgradeGNMA?Ofcourse.AndtheFDIC?Whatthehellwillreposdoonmarketopen?The
NYFedsaysitwon’taffectanything.Don’taskme,Ijustworkhere.AndhowcanyourateFranceAAA?AndstillgiveAAormoretoItalywhenthemarketissayingtheyaregettingclose
tojunk?
SidebetforMonday.Thiscouldmakemelooklikeanidiot,butIthinktreasuryyields
fallastherisk-offtradeincreases.Canthiscomeataworsetimeforanervousmarket?Bythe
way,maybeyouwanttogolongKimberlyClark,astheymakeDepends(theadultdiapershere
intheUS,formynon-USreaders),becausesalesaregoingtoskyrocketallacrossthefinancial
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markets.
CanwesayEndgame,gentlereader?Madness.Andnowontotheregularletter.More
tofollowMonday.
__________
ThisweekIwritefromMaine,where,whenwelandedinthefloatplaneatLeen’sLodge
inGrandLakeStreamonThursday,welearnedthatthemarkethadcloseddown512points.I
wasintheplanewithNourielRoubiniandJimBianco(plusaFedofficialtobenamedlater),
whereforwhateverreasonwecouldgetreceptiononandoff(nophoneworksatthelodge).
Wewerejustwatchingthemarketfall.ItisfuntositnexttoRoubiniasamarketcrashes.He
knowsALLthemarketcrashjokes.
So,asismynormalroutineforthisfishingtriptoMaine,Itaketheweekoffandinvitea
guestcolumnistin.ThisyearitisKeithFitz-Gerald,whomIhaveheardspeaktwiceandhave
startedreading.HehaslivedallovertheworldandspendsalotoftheyearinJapan,andisa
trueexpertonemergingmarkets.Iamafanofinvestinginemergingmarkets(asIagreethey
arethefuture)butdonotconsidermyselfanywhereclosetoKeith’slevelofexpertise.Sothis
weekwetakealookatthecaseforemergingmarkets.
IfyouareinterestedinsubscribingtoKeith’sletterandlearningmoreaboutemerging
markets,youcangoto
https://purchases.moneymappress.com/MMRKFGSHORT4950to79/LMMRM800/.It’sfairly
inexpensiveandmyreadersgethalfoff.Now,let’sjumpin,andIwillendwithsomeclosing
comments.
TheCaseforGoingGlobalIsStrongerThanEverByKeithFitz-Gerald
ChiefInvestmentStrategist,MoneyMapPress
Ifwehavelearnedanythingfromthecurrentfinancialmess,it’sthatbuildingwealthis
dependentonrationalanalysis,carefuldecisionmaking,andriskmanagement.That’swhy
stickingclosetohomeatatimewhenourmarketsaremoreuncertainthaneverisarecipefor
disasterandabsolutelythewrongthingtodo.Notonlywillyoumissoutontheworld’sfastest-
growingmarkets,buttheoddsareexceptionallyhighthatyouwillmissasmuchas50%ormoreinpotentialreturnsoverthenextdecade.
Don’tgetmewrong.
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Ifyouchooseto“stayhome”orgowithwhatyouknow,whichiswhatalotofinvestorsare
doingrightnow,chancesareyouwillprobablydookay.Afterall,therewilleventuallybeaU.S.
economicrecoveryandamarketrebound.
Butknowthis.
Youwillhavetowatchothersoutperformyouby50%,75%,even100%ormore–foryearsto
come.Addinginsulttoinjury,you’llhavetodealwiththeever-presentknowledgethatyou
couldhavebeenoneofthem.
Ifyoucanlivewiththis,fine…butmostinvestorsIknowwon’tbeableto.
TheU.S.MarketsAreStillInTrouble
DespitewidespreadbeliefinsidetheBeltwaythattheU.S.economyisonthemend,realityis
thatit’sgoingtobealongtimebeforeU.S.marketsreturntonormal–ifthereissuchathing
anymore.
Ourrealestatemarketsarelikelytobehobbledforadecadeorlonger,ourconsumersare
badlyscarred,chronicunemploymentislikelytobeapermanentfixtureintheeconomic
landscapeforatleastthenextfewyears,andthepersonaldeleveragingwe’reseeingasmost
Americanspullintheirhornsisreallystillinitsinfancy.
Factorintheeviscerationofournationalwealth,thedebtdebacleonbothsidesoftheAtlantic,
fecklessleadership,andregulatorswhoaretryingtomakeuplostgroundforhavingmissedthe
crisisinformation,andwehavearealwitch’sbrew,theresultsofwhichcannotbe
understated,especiallywhenitcomestocapitalmarkets.
Governmentbondmarkets,asIhavenotedmanytimesinpresentationsaroundtheworld,are
pricinginslow-growthtono-growthexpectations,asevidencedbythe10-yearnotes,which
havehistoricallyreflectedgrowth-rateexpectationsfortheso-calleddevelopedworld.Thisis
especiallyproblematicgiventhedebtcarriedbytheUnitedStatesandmostofitscolleagues.
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Figure1:Source:Bloomberg,FederalReserveBankofSt.Louis,Calamos.com
Thenumbersareevenstarkerwhenviewedthroughthelenseofforward-lookingannualreal
yieldonten-yeartreasuries,whichpencilsouttoapaltry0.6%,assumingannualizedinflationof
2.4%ayear.
Obviouslytheinflationnumbersarehighlysuspect,asisanythingcomingoutofWashington
thesedays,butthisiswhatwe’vegottoworkwith.
Ifindmyselfstruckbyaterriblesenseofdéjàvu,becausetheU.S.–debtdealornot–appears
tobechartingacoursedownthesametroubledpathJapanhastrodsince1990,whichis
somethingIfirstnotedinearly2000,baseduponmyfirst-handexperienceinthatnation.
Unfortunately,thispathislikelytobecharacterizedbythesameproblems:sovereigndebt
overburdenthatmakestheGreekslookpositivelymiserly,stagnantnationalwealth,andslow
GDPgrowthdespitetrillionsin“stimulus”thatisunlikelytocreateanyrealreturnswhatsoever.
Asbleakasthissounds,however,Ialsofindmyselfsalivating,becausehistoryshowsthat
periodsofgreatcrisisarereallyjustopportunitiesindisguise.
Caseinpoint,manyemergingmarketsarenowemerginginnameonly.They’vebecome“BEEs”
orBigEmergingEconomies,withsuperiorrisk-rewardcharacteristics,newlyunbridled
consumerpower,and–gasp–someelementofadultsupervisionwhenitcomestofiscal
fitness.
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Notsurprisingly,theirbondmarketsarepricinginanentirelynewsetofexpectations,6%-9%
growth,andcapitalmarketsthatmayexceed$300trillionby2025,accordingtoproprietary
research…morethan60%ofwhichwillcomefromoutsidetheestablishedplayersofthe
UnitedStates,theEU,andJapan.
Atatimewhenwearehamstrungbyourownproblems,thisishardtoimagine.Butit’snotdifficulttounderstand:sinceWWII,developedcountrieshavecontributedeverlesstoglobal
growth.
It’snotthatwe’refallingoffthemap.Infact,quitetheoppositeishappening,andother
nationsaresimplycominguptospeed.
Figure2:Source:PIMCO,HaverAnalytics,IMF,FGRP
What’smore,manyofthesameemergingmarketsweusedtoregardaslittlemorethan
entertainingbackwatertradingpartnersarenowsomeoftheworld’sbiggestforeigncreditors.
Virtuallyallhavelargereserves,andtheimportanceofthisdevelopmentcannotbe
understated.
Here’swhy.
Incontrasttoyearspast,whenafinancialcrisiswouldhaveeruptedintoafiscalcrisis,countries
likeChina,Brazil,andothershaveseentheircurrenciesstrengthen.Thismakestheirdollar-denominateddebteasiertorepay,especiallyasacreditor,becauseanyweaknessinthe
currencyactuallyimprovesfiscalaccounts.
Atthesametime,beinganetexternalcreditorgivesemerging-marketpolicymakerseconomic
flexibilitythatsimplywasn’tpossibleadecadeago.Asaresult,manyemergingeconomies,
particularlytheBEEs,cannowprovideasortofcountercyclicalstimulusthatiscapableof
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stimulatingdomesticdemand,evenastheybecomelessreliantontheirexports.Thisiswhy
China,forexample,hasnotcrashedandBrazilrefusestobuckle.
AccordingtotheInternationalMonetaryFund,worldwideofficialforeignexchangeholdings
reached$9.69trillioninthefirstquarterof2011.That’sa17%increaseyear-over-yearin
aggregate.
AsoftheendofQ12011,totalforeignexchangeholdingsbyadvancedeconomieswere$3.16
trillion,andtotalforeignexchangeholdingsbyemerginganddevelopingeconomieswere
approximatelydoublethat,or$6.53trillion.
Ifyourjawisnotontheflooralready,considerChina.AsofMarch2011,Chinahad$3.1trillion
inreservesallbyitself,whiletheU.S.showedmerely$128billionintheproverbialpiggybank.
Thismeansinnouncertaintermsthatsomenations,likeourown,havelittleornowealthto
drawuponwhileotherscouldrecapitalizetheirfinancialsystemsseveraltimesoverandstill
havechangeleft.
UndercapitalizationMakesEmergingEconomiesMoreEfficient&DevelopedEconomiesLess
Efficient
HistoryshowsthatoneofthesinglebiggestdragsonanyeconomyissomethingIcall
overcapitalizedinfrastructure.Whatthismeansisthat,dollarfordollar,thereissomuch
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moneyavailablethatinvestmentsbecomeaprocessofoverallocationorovercapitalization.Or
both.
Insimplelanguage,thismeansthere’ssimplytoomuchmoneychasingtoofewquality
opportunities,sothingstendtogetbiduporovercapitalizedintheprocess–likehouses,cars,
creditcarddebt,andmortgages.Allofwhichare,inreality,generallydepreciatingassetsthatcreatenothingmorethantheillusionofprofitsforveryshortperiodsoftime.
Underthisscenario,laborproductivitygenerallyrisesbutcapitalproductivitygenerallyfalls,
whichiswhygovernmentanalystsareflyingblind…theycannottellthedifference.
Ontheotherhand,theBEEsandmanyemergingmarketsdonothavesuchtroubles.Atleast
notyet.
Ifanything,they’vegotthereversetocontendwith:extremelycompetitivelaborthat’sfueled
byapowerfulcombinationofambitionandgenerallygrowingcapitalefficiency.
What’smore,becausetheyarestartingfromanincrediblylowbase,itdoesn’ttakealottoget
themmovingintherightdirection.Many,infact,areabletoengineeralevelofcapital
efficiencythatfaroutstripsourown,ledmostnotablybyChina,Brazil,andIndia.And,thanksto
millionsofunderemployedpeopleinlow-productivityjobs,theyhaveahugehumanreservoir
fromwhichtodrawfordecadestocome.Wedon’t.
AccordingtotheMcKinseyGlobalInstitute,theaveragecapitaloutputworldwidebycountryis
253,meaningthatittakes253dollarsincapitalstocktogenerate$100ofglobalGDP.Anation
likeChinacanachievethiswithaGDP“investment”percapitaofbetween$1,500-$2,500per
person,whereastheUnitedStatesrequiresmorethan$40,000andhasacapitalstockratioofapproximately205%.
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Whatthissuggestsisthathigh-GDP-per-capitanationsrequiremoremoneytomaintainthe
samerelativeefficiencyasnationswithlowGDP-per-capitaratios.
It’snowonder,then,thatwhiletheWestisforcedtocontendwithaproverbialalbatross
aroundournecksthat’sdefinedbysovereigndebtandbadlybrokensocialcontractsthat
nobodywantstorelinquish,othernationsareembarkingonagrandrunwayofgrowththatwill
resultinthegreatestgameofcapital“catch-up”theworldhaseverseen.
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Figure3:Source:IMF,McKinsey&Co.,FGRP
EmergingMarketsStillUndervalued
Obviouslythisraisessomeinterestingquestions,especiallywhenitcomestowhichmarkets
mayrepresentthebestinvestmentopportunities.
Here,too,thedataisquiteclear.
AccordingtoaJuly2011reportfromInvestmentMarketRiskMetrics,USmarketsstillappear
overvalued,eventhoughtheyaredownsubstantiallyfromotherpeaksoverthelast131years.
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Figure4:Source:PensionConsultingAlliance–InvestmentMarketRiskMetrics
Ontheotherhand,emergingmarketsstillappearcheap.Grantedthey’renotatthelevelswe
witnessedin2008-2009orintheearly2000s,butonecanmaketheargumentthey’re
undervaluedevennow.AndthereforemoreworthyofinvestmentthantheirWestern
counterparts.
Figure5:PensionConsultingAlliance–InvestmentMarketRiskMetrics
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GlobalCapitalShiftIsAccelerating
Againstthisbackdrop,it’snowonderthatmoneyisleavingthenannystatesoftheWestand
headedtotheFarEast,aswellastonationsthatarebackedatleastpartiallybynatural
resources.ThisincludesportionsoftheMiddleEastandSouthAmerica,too.
Inperhapstheultimateirony,ourownweakdollarpolicies,TARP,andQE2haveactuallymade
thiscapitalflightworse,becausetheyhavediminishedthevalueofthedollar.Sountil
Washingtonstopsjawboningandactuallydoessomethingproductivethatmakesmoneyfeel
welcomehere,thiswillcontinue.
Manyinvestorsthinkthisisnew,butinrealityit’sjustthecontinuationofatrendthatbegan
shortlyafterWWII,whenapproximately75%oftheworld’seconomicactivitytookplacewithin
ourborders.Wejustdon’tremember.
Today,thatfigureisreversed,andvarioussourcesestimatethatasmuchas75%oftheworld’s
dailyeconomicactivitynowtakesplaceoutsideourborders.
SomechalkthisuptothemythofAmericanindustrialmightandsuperiority.Inrealitywewon
bydefault,becausetherestoftheworldwasquiteliterallyinashesandhadn’tyettakenthe
field.
Now,however,they’rereadytoplay,whichiswhythetrendinglobalconsumerspendinglooks
likeaskijump,evenastheUnitedStates’shareofthatisindeclineoratbestflatlining.
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Figure6:Source:PIMCO,CreditSuisse,FGRP,IMF
Astohowthingswilllookinafewinnings,whatwe’redealingwithissimplyanumbersgame,
especiallywhenitcomestoconsumption.
Peopleforget,forexample,thatChina’smiddleclassaloneisestimatedtobemorethan300
millionpeoplestrong.FactorinIndiaandmuchofSouthAmericaandyouaretalkingaboutan
unprecedentedincreaseinconsumerismthatmayultimatelyinvolveasmanyas3outofevery
5peoplealiveontheplanettoday–that’sentirelyoutsideourborders.
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TheBiggestGrowthWillBeintheMostObviousPlaces(andSectors)
WhenIlookattheworldofthepastandtheworldofourfuture,somethingsjumpout.Chief
amongthemistheimmediateeffectthatnewlyemergingnationswillhaveonthingstherestof
ustakeforgranted–likeinfrastructureandinfrastructure-relatedholdings–whichareamong
mytopchoicesatthemomentandhavebeensincethiscrisisbegan.
Asrecentlyas1970,approximately25%ofglobalGDPwasinvestedininfrastructure,whichis
definedasfixedassetsandequipmentbytheMcKinseyGlobalInstitute.Notsurprisingly,this
declinedto20%in2010,leadingmanyanalyststomistakenlybelievethatglobalgrowthwas
slowing.
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Figure7:GlobalInvestmentRateasa%ofGDP,Calamos.com
Nothingcouldbefartherfromthetruth.
Whatisactuallyhappeningisthattheworldisbeingsplitintoatwo-speedeconomy:those
countriescapableofcreatinghigh-productivitycapitalinvestmentsandthosethatcannot
createsuchthingsabsenthuge,misguidedstimulusprogramsandbailouts.
Theformeraremuchmoreattractiveinvestments,becausetheyarecharacterizedbygrowth,
whilethelattershouldgenerallybeavoidedbecausetheywillbeadragoncapitalfordecades
tocome,absentacompletesimultaneousfiscalreset.
Generallyspeaking,thissuggestsmovingawayfromAmerican-,European-,andJapanese-
centricchoicesandintocompaniesthatfavorthefastergrowthofemergingmarketsandBEEs,
regardlessofwheretheyaredomiciled,i.e.,ontheNYSE,London,orTokyoexchanges.
Doingsowillhelpinvestorscapitalizeonburgeoningdomesticgrowthwhileatleastpartially
isolatingtheirportfoliosfromtheinevitableslowdownsandstagnantcapital“stock”discussed
above.It’sworthnotingthatanincreasinglylargepercentageofexportsthatwereoncebound
forourshoresarebeingrefocusedtootheremergingmarkets,suggestingthatfuturegrowth
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willbeevenlessdependentondevelopedmarketstabilitythanitisnow,whichisaprettyscary
thoughtifyou’renotpreparedforit.
Bythenumbers,thistooisprettystraightforward.
Unfortunately,thisiswhereitgetstrickyandwherewemustdepartfromthepastwhenit
comestoourinvestments.
ConventionalDiversificationWon’tCutItAnyLonger
Formillionsofinvestors,theverynotionofdiversificationisappealing:tosplityourassetsupso
thatnoonedeclinewilltakeeverythingdownatonce.Unfortunately,witheverythinggoingonnow,thisislikerearrangingthedeckchairsontheTitanic,andaboutaseffective.
Today’sfinancialmarketsneedaconcentrationofassetsthat’scharacterizedbysignificant
emphasisoncreditornationsversusdebtornations.Atthesametime,investorswhodon’t
wanttogetleftfarbehindwouldbewisetofilltheirportfolioswithcompaniesIcallthe
“glocals,”orbigmultinationalfirmswithstrong“fortress”balancesheets,experienced
managers,andgloballyrecognizedbrands.Technology,connectivity,andindirectresource
playsallcometomindhere,asdodividends,whichhelpoffsettheriskswetakeasapartofthe
investingprocess.
Ialsobelievethatinvestorswanttogenerallybelongresourcesandcommoditiesforthe
foreseeablefuture.BothwillbegreatplacestohangoutastheWestcomesapart,whilealso
providingameaningfulinflationhedge.Ifthingsdon’tcomeapart,that’sgreat,becausethey’ll
zoomhigherondemandasitresumes.
Andfinally,Ithinkinvestorswhobuyintotheinternationalgrowththatisourfuturewilltake
advantageofadefinitecurrencybiasthatwillkeepyourmoneyinvolvedwiththeefficient
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capitalcountrieswhilegenerallyavoidingtheslackers,exceptinveryspecificinstancesandonly
thenwithriskcapital.
Youcanfigureoutprettyquicklywhichiswhichbylookingatthecostoflivingversusvalueof
investments.Anytimeyouseetheformeroverwhelmingthelatter,it’stimetogo,asisthecase
fortheUnitedStatesandEuropenow.
Figure8:Source:PIMCO
Risks(andthereareplenty)
Nodiscussiononemergingmarketswouldbecompletewithoutaddressingthe800-pound
gorillaintheroom–China.Loveitorhateit,thatnationisonthemove.
Morebluntly,Chinawillaffecteveryinvestmentclassontheplanetforthenext100years,
whichiswhyinvestorswouldbewisetocometotermswithit.Ithinkthedecisionispretty
easy,evenasitisprettygraphic:theDragoniscomingtolunchonTuesday.Theonlydecision
youhavetomakeiswhetheryouandyourmoneyaregoingtobeatthetableoronthemenu.
Thesamecouldbesaidaboutvolatility.Ithinkit’sheretostay,particularlyasourown
demographicshiftresultsinfurthercurrencydebasementandinflationarypressure.Youcan’t justwishaway$202trillioninunfundedliabilities,despitewhatthoseinourcapitalmightthink.
Nomatterwhichwayyoucutit,it’sverysimple,asIseeit:theWest(includingJapan)faces
severestructuralimbalancesthat,whencombinedwithlimitedwillingnesstodealwith
meaningfulausterity,willholditbackformanyyears–whichiswhyI’drathergowithgrowth
anyday.
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Inclosing,Iwanttoleaveyouwithonemorethought.
Eventhoughwehavetalkedextensivelyaboutwhythecaseforemergingmarketsisstronger
thanever,IamnotabigfanofabandoningtheU.S.,whichiswhatsomeofmycolleagues
advocate.
TheUnitedStatesisanationfilledwithresilient,cleverpeople;anddespitethefactthatthe
chipsaredown,Iwouldn’tbetagainstit.
Wewillfindourwaythroughthismess,eventhoughthepathwemusttakeisn’tclearlydefined
norbrightlylit…yet.
Bestregardsforgreatinvesting,
KeithFitz-Gerald
MaineandQE3,OperationTwist,etc.?
IclosefromMaine,wheretheBloombergtruckwasjusttoldtostay,becauseevidently
thereisabouttobesomethingannouncedthatisgoingtobehuge(itischaracterizedasan
embargoedstory,whateverthatis).Andtheyhavealltheseeconomisttypesinoneplacefor
comment.Itreallyisanall-starline-upinoneplace.Gofigure.Itis6pm,andIhavenoidea.
MaybeI’llwritealast-minutenote.Wait:Latestrumor:agovernmentofficialtellsABCNews
thatthefederalgovernmentisexpectingandpreparingforthebondratingagencyStandard&
Poor’stodowngradetheratingofUSdebtfromitscurrentAAAvalue.Thatshouldmakefor
interestingdinnerdiscussion!
Thishasbeenaveryinterestingtimetotalkeconomicslateatnight.SomeVERYserious
economistsaretalkingQE3andanotherversionofOperationTwist(circa1948,wheretheFed
fixedlongbondrates)nextyearaswerollintorecession.OthersthinktheFedhastodo
nothing.Iamsittingandlearningandmaybethrowinginanopinionortwo.Iwillreportback
nextweek.
TodaymyyoungestsonTreyandIwentfishing.Thatis,fishingasopposedtocatching
anything.Onebassapiece.Butthetalkatlunchwasgoodandthebanterfriendly.Weflyback
onMonday.Thisismy6
th
yeartocomewithTrey,anditisourfavoriteweekoftheyear.
Yourhopingtobecatchingtomorrowanalyst,
JohnMauldin