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Wednesday, August 22, 2012

Past performance is no guarantee


Past performance is no guarantee of future results. Almost all investment literature contains this warning bit of wisdom, which few heed. We all continue to believe that tomorrow will be like yesterday. Shocked when it isn’t. We talk about the “Black Swan” event, the once in a hundred year event. An outlier on the far edge of the bell curve. Quickly rejoining the other lemmings and reassessing our risk tolerance.
One past performance we all are sure will continue is inflation. Many are predicting hyperinflation due to the Federal Reserve’s money printing. Inflation has dogged us since the 1930s and we are certain about the future results. Well call me doubting Thomas and label me a traitor. Deflation is coming.
Inflation and deflation is the difference between supply and demand. We have experienced greater demand than supply since World War 2, this has created constant inflation. Economists have even developed Supply Side Theory to help the poor industrialist and financial wizards deal with the crushing burden of supplying supply. Since the 2007 subprime collapse the equation has reversed. We now have more supply than demand. On a global basis all countries have greater supply than demand. Consumers have cut spending to pay their debt, Governments have cut spending to cut debt, and companies cut spending as there is less demand for their products. This enormous worldwide debt will require years to settle. The overhang of houses will take years to clear. Young college graduates have impossible student loan debt that will take years to payoff. The prolific consumer of the last 40 years is starting to save money, not spend money.
As consumers scale back on spending due to smaller paychecks and layoffs the supplier companies have to reduce employee head count and increase productivity of the fewer remaining employees to maintain margins. This reduces the consumer's ability even more and creates a self feeding cycle of less and less consumption. As demand drops prices will drop while chasing less and less wage income. Commodities have been dropping in price due to oversupply since 2008. The current price is supported by countries warehousing copper and iron not because there is production demand. The world’s automobile production is 74% of capacity. I hear that China will buy the difference, that China will become the new consumer nation to replace the decimated America consumer. This will keep us all fat, happy and rich. Even if this silliness is true it will take many years for peasant farmers and Ipad assemblers to become McMansion owners.
I don’t know what deflation feels like, I have never experienced it. Will price drops make me wait for further price drops before I buy? Will this be good for my fixed income status? Actually, I look forward to a 49 cent hamburger on sale for 29 cent.

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