8/14/2019 Volume 1 14 Risk Uncertainty in 2010 Dec 21 2009
1/12
BOECKHINVESTMENTSINC.,17501002SHERBROOKESTREETWEST,MONTREAL,QUEBEC.H3A3L6TEL.5149040551,[email protected]
VOLUME 1.14
DECEMBER21,2009
There have been five overriding themes for
our investment letters during the past year.
Below we list and review them.
1) Expanding liquidity drives financial
markets, particularly when it occurs in the
face of a sub-par but recovering economy
and weak price inflation. This is the sweet
spot in the cycle we so often talk about, and
it is the best of all times for stock and
corporate bond prices when perception of
risk abates.
2) The Great Reflation underway since
late 2008 has done its first job - aborted
what surely would have been a full scale
depression at least on the scale of the 1930s.
That was Act I.
3) No one should believe that the huge
reflation underway will make the economy
and financial system whole again. The
private sector debt excesses were far greater
by 2008 than they were in 1929. A good part
of the reflation effort is to transform private
debt into public debt, and this will surely
create another, different debt monster. As
the year draws to a close, credit rating
agencies are starting to downgrade
sovereign debt and credit default swaps
(CDSs) and are showing increased concern
that some major developed countries are
going to have problems servicing their debt
(e.g. Japan, U.S., etc.).
The markets are starting to tell us that
Governments with brittle, over-extended
fiscal positions will soon have to put in
place credible fiscal consolidation -- tax
increases, expenditure cuts, decline in
services, etc. This means more deflation,
more uncertainty.
RISK & UNCERTAINTY IN 2010:
Hopefully Some Return Too
8/14/2019 Volume 1 14 Risk Uncertainty in 2010 Dec 21 2009
2/12
THEBOECKHINVESTMENTLETTER WWW.BOECKHINVESTMENTLETTER.COM 2
4) Zero interest rates in the U.S. together
with Federal Reserve asset purchases, much of
it low quality, has done its job of inflating asset
prices which improves balance sheets. Better
financial markets greatly help capital raising
ability, further strengthening balance sheets.
As a result, they are much improved. The
question is over sustainability. Fears of
renewed asset bubbles have surfaced,
complicating Fed and other central bank
decision making. Do they risk tightening too
soon or too late? Does a middle ground exist?
Zero interest rates are an extreme anomaly and
cannot last unless the U.S. economy remains
permanently depressed and in deflation like
Japan has been for 20 years. This seems
unlikely but cannot be ruled out.
5) The great flaw in the international
monetary system has allowed the U.S. - the
key reserve currency country in the world - to
run up a $4 trillion tab with foreign central
banks and has created excess liquidity and
asset bubbles in countries buying those dollars.
It has also contributed mightily to the
destruction of savings and investment in the
U.S., and has created massive disequilibria in
the global economy and financial system.
Economics 101 tells us clearly that all
disequilibria eventually get corrected. The
interesting questions are how and when? That
will be the story for Act II of the drama and it
hasnt been written yet.
As the year 2009 draws to a close, there
is clearly an aura of unreality. We barely
survived a near-death experience nine months
ago. However, the pain and the fear for most
people were brief. It was not like the 10-year
depression in the 1930s that changed attitudes
for two generations. The recent experience
probably won't change many peoples' attitudes
at all, and may even have a perverse, moral
hazard effect. If the U.S. and other
governments are always going to bail out the
banks and other over-indebted, overleveraged,
reckless players, and stick the costs onto the
sober and prudent, why not join the former? As
Mark Whitehouse put it in a recent article,
8/14/2019 Volume 1 14 Risk Uncertainty in 2010 Dec 21 2009
3/12
THEBOECKHINVESTMENTLETTER WWW.BOECKHINVESTMENTLETTER.COM 3
"Let's default and go to Disneyland - the
American dream - default and then rent."
The music is playing again, people are
up on the dance floor and the bankers
(somewhat diminished in numbers) are getting
rich once more and raising tens of billions of
dollars in equity on the much-improved stock
market to pay off their TARP loans so they can
pay out mega bonuses. Meanwhile, the banks
are sitting on hundreds of billions of dollars of
bad loans with more to come (default lags can
be long).
The question for investors is - do you
get up on the dance floor like everyone else
and pretend that the crash was a bad dream?
Or, do you pay attention to the unresolved
problems, do a little dancing, but be ready to
grab a chair when the music stops?
A key point we have been making all
year and will continue to do, is that the stock
market in March 2009 met most of the criteria
for a durable bottom. These were: good
valuations, massive fear, very expansionary
monetary policy and government through
intervention, bailouts, and stimulus etc. to do
whatever it takes to put air back in the burst
balloon. Simply put, the government took the
downside out of the economy and risk assets.
The odds were very high that the
market environment would be good for some
time and it has stayed that way. However, the
so-called fundamentals are very artificial - the
stimulus, the subsidies (first-time home buyers,
cash for clunkers, moratorium on foreclosures,
etc.), the zero interest rates - none of that can
last.
A second key point we have been
emphasizing is that no one knows what the
underlying economic conditions are really like,
and more important, what they will look like in
6-12 months. No one knows how sensitive the
still over leveraged economy is to a rise in
interest rates. No one knows how long nervous
foreign central banks will keep buying dollars.
No one knows whether the recovery in asset
prices might morph into a full-blown asset
bubble. Or the reverse. No one knows when
8/14/2019 Volume 1 14 Risk Uncertainty in 2010 Dec 21 2009
4/12
THEBOECKHINVESTMENTLETTER WWW.BOECKHINVESTMENTLETTER.COM 4
sharply rising government debt: GDP ratios
will hit the wall, as in the case of Greece.
No one knows how much debt is too
much. The private sector debt super cycle went
through a process of steadily rising over 25
years to reach 170% of GDP. All along the
way, the same questions were being asked -
how much is too much? The answer was: a lot
more than most people thought. But when you
get to the end, they dont ring a bell to give
you a warning. Think of the elastic band
analogy. You keep stretching it; it weakens
gradually until a certain point. Along comes
a shock and it snaps. That happened in 2008
with the private debt structure. It will happen
with the government debt if a credible plan is
not put in place to bring it under control, but no
one has any idea of when. It probably won't be
for quite a while, but no one will give you a
written guarantee.
A third key point we strongly believe is
that there is no long term any more for
investors. It is totally inappropriate in this
environment to think in terms of point
estimates -- how high the stock market might
go and how long it will keep rising. Estimates
of numbers and time are useless and, in this
highly uncertain world, no one should believe
such forecasts.
The issue is risk and uncertainty. The
dilemma for investors as they face near-zero
returns on safe, liquid, short-term assets is that
if they want some return, they are necessarily
driven to accept a level of risk that is
uncomfortable and unknown. While this is
always true, the difference going into 2010 is
that a lot of things could go very wrong on
very short notice. For most of the post-war
period, that was not the case.
Investment Conclusions
Our take on the investment environment as the
year draws to a close is as follows:
1) We are not yet in a full-fledged asset
bubble, although as we pointed out last month,
gold and other commodities may be a lot closer
to one. The recent correction in those markets
is helpful and the injection of a little risk may
8/14/2019 Volume 1 14 Risk Uncertainty in 2010 Dec 21 2009
5/12
THEBOECKHINVESTMENTLETTER WWW.BOECKHINVESTMENTLETTER.COM 5
curb speculative juices for a while. Risk assets
in most developed markets are still well below
old highs. The exception is real estate outside
the U.S. Quite a few markets are getting too
hot for comfort.
2) The Fed and other central banks will
continue to talk of exit plans, but they are as
concerned as we are that underlying economic
conditions have been driven by artificial
factors and are not nearly as strong as recent
data suggests. Remember, the two most
powerful influences driving Fed policy are
first, unemployment, and second, elections.
There is 10% unemployment and a much
worse picture counting discouraged workers
and structural unemployment. With a key
election next year, the Fed will not be
tightening any time soon.
3) Foreign central banks will continue to
hold their nose and buy enough dollars to
prevent a collapse. Dollar erosion over time,
with periodic rallies is a better bet. Moreover,
dollar short positions are huge, so dont count
out sharp counter-trend moves.
4) The world will remain very
deflationary for some years and Government
bond yields are very low as a result. The risk is
on the side of an increase, but it will likely be a
gradual trend.
5) There will be enough economic
strength for awhile to support corporate credit.
Spreads against Treasuries should be flat to
down. That will continue to provide
opportunities to enhance returns.
6) The stock market environment will
remain good for the time being. Profits have
recovered substantially, liquidity is plentiful,
and interest rates are so low that investors will
continue to be driven to riskier assets - stocks,
corporate bonds, commodities, emerging
markets and probably gold, although that looks
like a very speculative market.
7) Markets of countries, ex. the U.S., with
strong currencies, sound finances, stable
politics and with commodities making up a
large percentage of the GDP, should continue
to do very well. Examples are Canada,
Australia, Brazil, Columbia and Norway.
8/14/2019 Volume 1 14 Risk Uncertainty in 2010 Dec 21 2009
6/12
THEBOECKHINVESTMENTLETTER WWW.BOECKHINVESTMENTLETTER.COM 6
There are more. High-growth developing
countries like China and India will also do
well, but as valuations get stretched, volatility
will increase a lot. Good entry points are
essential.
A final note - remember the U.S.
reflation is an experiment never before
performed in peacetime except in post-1989
Japan. The lesson there is not very consoling.
Japan never got past Act I - the avoidance of a
depression. Act II, as we pointed out, is all
about restoring equilibrium and returning to
sustainable, non-inflationary growth. Japan has
had less than 1% real growth for 20 years even
with zero interest rates. Lack of growth has
pushed the debt to GDP ratio close to 200%.
Forget an easy solution; there does not seem to
be any solution and ultimately there will be a
yen collapse and a sharp rise in interest rates
that will cause havoc with government debt.
However, the U.S. is not Japan; there
are many differences which we will explore in
another letter. The point is that the U.S. is
experimenting with the unknown. Act II of the
Great Reflation lies ahead. Therefore,
investors, as we have emphasized before, must
look for milestones to assess whether
underlying conditions are changing. The most
important to watch are:
1. The dollar
2. Treasury bond yields
3. Corporate credit spreads
4. Credit defaults swaps on sovereign debt
We have added the last one to our
previous list because credit rating agencies are
getting nervous and are still licking their
wounds after their catastrophic performance
prior to the crash of 2008. There are, of course,
a variety of other milestones to watch which
we will be monitoring. For the time being, we
don't see any significant signs that the
liquidity-driven improvement in asset markets
won't continue into 2010. But remember, this is
a risky, uncertain world; you should carry
more liquidity than normal, be more risk
averse if you are not in a position to recoup
8/14/2019 Volume 1 14 Risk Uncertainty in 2010 Dec 21 2009
7/12
THEBOECKHINVESTMENTLETTER WWW.BOECKHINVESTMENTLETTER.COM 7
losses easily and if you have taken a big hit to
your net worth as a result of the crash.
Tony & Rob BoeckhDecember 21, [email protected]
*All chart data from IHS/Global Insights, andmay not be reproduced without writtenconsent.
8/14/2019 Volume 1 14 Risk Uncertainty in 2010 Dec 21 2009
8/12
The
BoeckhInvestmentLetter WWW.BOECKHINVESTMENTLETTER.COM 8
Stocks
8/14/2019 Volume 1 14 Risk Uncertainty in 2010 Dec 21 2009
9/12
The
BoeckhInvestmentLetter WWW.BOECKHINVESTMENTLETTER.COM 9
Commodities
8/14/2019 Volume 1 14 Risk Uncertainty in 2010 Dec 21 2009
10/12
The
BoeckhInvestmentLetter WWW.BOECKHINVESTMENTLETTER.COM 10
Currencies
8/14/2019 Volume 1 14 Risk Uncertainty in 2010 Dec 21 2009
11/12
The
BoeckhInvestmentLetter WWW.BOECKHINVESTMENTLETTER.COM 11
Interest Rates
8/14/2019 Volume 1 14 Risk Uncertainty in 2010 Dec 21 2009
12/12
The
BoeckhInvestmentLetter WWW.BOECKHINVESTMENTLETTER.COM 12
CORPORATE SPREADS AND VIX
Top Related