Sunday, May 20th, 2007
Inflation is rampant but the stock market isn’t going down
One problem I’m working on is trying not to be too bearish too often.
In the past year or so I’ve been influenced by the camp that believes inflation is rampant.
As it turns out that camp is dead right … and dead wrong!
It is rampant if you go by the purely technical cause of inflation: an increase in money supply.
Money supply has been surging around the world.
The problem is that it hasn’t shown up in rising consumer prices, so central banks haven’t had a reason to sharply increase interest rates as bears were expecting.
This opinion piece by British historian Niall Ferguson is one of the best summaries of what is happening.
Yes money supply is increasing, but at the same time cheap consumer goods from China are keeping prices low.
As Ferguson says:
In our time, unlike in the 1970s, oil price pressures have been countered by the entry of low-cost Asian labour into the global workforce. Not only are the things Asians make cheap and getting cheaper, competition from Asia also means that Western labour has lost the bargaining power it had 30 years ago. Stuff is cheap. Wages are pretty flat.
As a result, monetary expansion in our time does not translate into significantly higher prices in shopping malls. We don’t expect it to. Rather, it translates into significantly higher prices for capital assets, particularly real estate and equities. The people who find it easiest to borrow money these days are hedge funds and private equity firms. Through leveraged buy outs, the latter can easily acquire companies and, by improving their cashflow, boost their valuations. These guys then buy houses in Chelsea with the millions they make.
So how should investors play this? I have found that you should focus on the trend of the market primarily. So long as it is up you should be largely exposed to stocks.
But the fact that true inflation (ie an increase in money supply) is rising means that risks are higher and being on margin is probably unwise. More conservative investors should also probably be limiting their exposure to equities to about 80 per cent.
Word Count: 341. This entry was posted on Sunday, May 20th, 2007 at 11:49 pm and is filed under Market direction, Niederhoffer On Growth. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.
