Saturday, September 6, 2008 0 comments ++[ CLICK TO COMMENT ]++

Miscellaneous Articles for the First Week of September

Some miscellaneous articles I found interesting. As usual, click through to get my personal opinion, if interested...

  • Inflation expectations decline sharply: Inflation was all the rage a few months ago but not so much now.
  • Sign of desperate times in the newspaper industry: You can see the decline in the newspaper industry when you look at how desperate, and hence risky, their present tactics are. The latest is word that The New York Times is merging several sections into one. By merging the sports section into a section that is led by business, you risk alienating all the sports readers. No one interested in sports would consider the paper serious in sports anymore. Maybe very few sports fan read the NYT so it may not matter much but whatever it is, I will bet that there will be a few less sports fans that will be reading the physical paper. (credit to NakedCapitalism for original mention)
  • Jamie Dimon and J.P. Morgan: Here is a feature-length story from Fortune on how Jamie Dimon has been successfully navigating the credit crisis. JP Morgan has avoided the subprime problems but there is a huge risk with its massive derivatives book.
  • The superbear case on China: Vitaliy Katsenelson presents several bearish arguments on China. I share similar views and that is one reason I had been bearish on China for a few years now. I was actually bullish a couple of years ago (I owned FXI, the China ETF) but got out due to some of the reasons Vitaliy cites. My main concern is excessive capital flow into fixed investment (basically, real estate, roads, shopping malls, and so on) and my view that there is massive overcapacity in China. The big threat for China is a deflationary bust, even though inflation is all the talk right now. Having said that, stars are aligning in China's favour and it may have a bright future after any "collapse" so it's worth keeping tabs and doing research.

Inflation Expectations Declining

One way to measure market expectations of inflation is to look at the spread between same duration Treasury bonds and TIPS bonds. This provides the bond market's view of future inflation. Many investors, including me, value this measure more than other commonly used inflation measures such as the gold price, money supply growth, and analyst estimates. MarketWatch has an article summarizing the present situation, along with the following chart:

Like any indicator, this isn't perfect but the great thing about this is that it is a market expectation. We don't have some guy in government or an investment bank, with very little of his/her personal investments on the line, coming up with an estimate. Instead, it is a measure that comes from actual bets made by investors placing their precious capital on the line.

As you can see, inflation expectations dropped sharply recently, to below 2%. It shouldn't be a surprise to anyone given that commodities have entered a correction, with the former $150+ oil or $1000 gold calls nowhere to be heard. Who knows if this is a temporary thing but if it can stay between, say, 1.5% and 2%, it would help. This is good news for the Federal Reserve and enables some options that weren't available to them earlier.

My personal view is that inflation is not a problem--at least in developed countries. I don't see inflation getting out of control unless there are some policy mistakes (i.e. wars, embargoes, tariffs, price controls.) However, I do think inflation will tick up over the long-term since rates are quite low compared to long-term history. This isn't rocket science; it's simply reversion to the mean. The situation is the opposite in developing countries, with many having nominal GDP growth of around 16%, inflation around 8% and real GDP growth around 8% (some of the latest numbers are actually worse but I think it's temporary.)

So whenever someone says something about inflation, you need to look at the region or country that is being discussed. I invest in US stocks with the assumption that inflation will be around 3% in the long-run. But if I did that for, say, Chinese or Vietnamese stocks, it would be a disaster. I haven't given it much thought but I would imagine that long-term inflation in China would be around 6% (it's higher now) but it likely won't be as bad for foreigners (in US$ terms) since the Reminbi appreciation should offset the inflation somewhat. Here is a chart from the Cleveland Federal Reserve comparing US and Chinese inflation over the last 18 years:

I believe Chinese government numbers are manipulated downward so a 6% long-term inflation wouldn't be anything drastic. Some country like India will probably have long-term inflation around 7% (it will be much worse at times due to government policy.)

Having said all that, I would never invest based on projected inflation. It's very hard to predict and some businesses can actually do well if inflation increases.

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