Professional Documents
Culture Documents
Volume 1 14 Risk Uncertainty in 2010 Dec 21 2009
Volume 1 14 Risk Uncertainty in 2010 Dec 21 2009
VOLUME 1.14
DECEMBER 21, 2009
our investment letters during the past year. of the reflation effort is to transform private
Below we list and review them. debt into public debt, and this will surely
markets, particularly when it occurs in the the year draws to a close, credit rating
and weak price inflation. This is the sweet sovereign debt and credit default swaps
spot in the cycle we so often talk about, and (CDSs) and are showing increased concern
it is the best of all times for stock and that some major developed countries are
corporate bond prices when perception of going to have problems servicing their debt
2) The Great Reflation underway since The markets are starting to tell us that
late 2008 has done its first job - aborted Governments with brittle, over-extended
what surely would have been a full scale fiscal positions will soon have to put in
depression at least on the scale of the 1930s. place credible fiscal consolidation -- tax
3) No one should believe that the huge services, etc. This means more deflation,
© BOECKH INVESTMENTS INC., 1750‐1002 SHERBROOKE STREET WEST, MONTREAL, QUEBEC. H3A 3L6 TEL. 514‐904‐0551, INFO@BCCL.CA
4) Zero interest rates in the U.S. together destruction of savings and investment in the
with Federal Reserve asset purchases, much of U.S., and has created massive disequilibria in
it low quality, has done its job of inflating asset the global economy and financial system.
prices which improves balance sheets. Better Economics 101 tells us clearly that all
financial markets greatly help capital raising disequilibria eventually get corrected. The
ability, further strengthening balance sheets. interesting questions are how and when? That
As a result, they are much improved. The will be the story for Act II of the drama and it
renewed asset bubbles have surfaced, As the year 2009 draws to a close, there
complicating Fed and other central bank is clearly an aura of unreality. We barely
decision making. Do they risk tightening too survived a near-death experience nine months
soon or too late? Does a middle ground exist? ago. However, the pain and the fear for most
Zero interest rates are an extreme anomaly and people were brief. It was not like the 10-year
cannot last unless the U.S. economy remains depression in the 1930s that changed attitudes
permanently depressed and in deflation like for two generations. The recent experience
Japan has been for 20 years. This seems probably won't change many peoples' attitudes
unlikely but cannot be ruled out. at all, and may even have a perverse, moral
5) The great flaw in the international hazard effect. If the U.S. and other
monetary system has allowed the U.S. - the governments are always going to bail out the
key reserve currency country in the world - to banks and other over-indebted, overleveraged,
run up a $4 trillion tab with foreign central reckless players, and stick the costs onto the
banks and has created excess liquidity and sober and prudent, why not join the former? As
asset bubbles in countries buying those dollars. Mark Whitehouse put it in a recent article,
WWW.BOECKHINVESTMENTLETTER.COM 2
THE
© BOECKH INVESTMENT LETTER
"Let's default and go to Disneyland - the intervention, bailouts, and stimulus etc. to do
American dream - default and then rent." “whatever it takes” to put air back in the burst
The music is playing again, people are balloon. Simply put, the government took the
up on the dance floor and the bankers downside out of the economy and risk assets.
(somewhat diminished in numbers) are getting The odds were very high that the
rich once more and raising tens of billions of market environment would be good for some
dollars in equity on the much-improved stock time and it has stayed that way. However, the
market to pay off their TARP loans so they can so-called fundamentals are very artificial - the
pay out mega bonuses. Meanwhile, the banks stimulus, the subsidies (first-time home buyers,
are sitting on hundreds of billions of dollars of cash for clunkers, moratorium on foreclosures,
bad loans with more to come (default lags can etc.), the zero interest rates - none of that can
be long). last.
The question for investors is - do you A second key point we have been
get up on the dance floor like everyone else emphasizing is that no one knows what the
and pretend that the crash was a bad dream? underlying economic conditions are really like,
Or, do you pay attention to the unresolved and more important, what they will look like in
problems, do a little dancing, but be ready to 6-12 months. No one knows how sensitive the
grab a chair when the music stops? still over leveraged economy is to a rise in
A key point we have been making all interest rates. No one knows how long nervous
year and will continue to do, is that the stock foreign central banks will keep buying dollars.
market in March 2009 met most of the criteria No one knows whether the recovery in asset
for a durable bottom. These were: good prices might morph into a full-blown asset
valuations, massive fear, very expansionary bubble. Or the reverse. No one knows when
WWW.BOECKHINVESTMENTLETTER.COM 3
THE
© BOECKH INVESTMENT LETTER
sharply rising government debt: GDP ratios estimates -- how high the stock market might
will hit the wall, as in the case of Greece. go and how long it will keep rising. Estimates
No one knows how much debt is too of numbers and time are useless and, in this
much. The private sector debt super cycle went highly uncertain world, no one should believe
years to reach 170% of GDP. All along the The issue is risk and uncertainty. The
way, the same questions were being asked - dilemma for investors as they face near-zero
how much is too much? The answer was: a lot returns on safe, liquid, short-term assets is that
more than most people thought. But when you if they want some return, they are necessarily
get to the end, they don’t ring a bell to give driven to accept a level of risk that is
you a warning. Think of the elastic band uncomfortable and unknown. While this is
analogy. You keep stretching it; it weakens always true, the difference going into 2010 is
gradually until a “certain” point. Along comes that a lot of things could go very wrong on
a shock and it snaps. That happened in 2008 very short notice. For most of the post-war
with the private debt structure. It will happen period, that was not the case.
WWW.BOECKHINVESTMENTLETTER.COM 4
THE
© BOECKH INVESTMENT LETTER
curb speculative juices for a while. Risk assets 4) The world will remain very
in most developed markets are still well below deflationary for some years and Government
old highs. The exception is real estate outside bond yields are very low as a result. The risk is
the U.S. Quite a few markets are getting too on the side of an increase, but it will likely be a
2) The Fed and other central banks will 5) There will be enough economic
continue to talk of exit plans, but they are as strength for awhile to support corporate credit.
concerned as we are that underlying economic Spreads against Treasuries should be flat to
conditions have been driven by artificial down. That will continue to provide
factors and are not nearly as strong as recent opportunities to enhance returns.
data suggests. Remember, the two most 6) The stock market environment will
powerful influences driving Fed policy are remain good for the time being. Profits have
There is 10% unemployment and a much and interest rates are so low that investors will
worse picture counting discouraged workers continue to be driven to riskier assets - stocks,
election next year, the Fed will not be markets and probably gold, although that looks
3) Foreign central banks will continue to 7) Markets of countries, ex. the U.S., with
hold their nose and buy enough dollars to strong currencies, sound finances, stable
prevent a collapse. Dollar erosion over time, politics and with commodities making up a
with periodic rallies is a better bet. Moreover, large percentage of the GDP, should continue
dollar short positions are huge, so don’t count to do very well. Examples are Canada,
WWW.BOECKHINVESTMENTLETTER.COM 5
THE
© BOECKH INVESTMENT LETTER
There are more. High-growth developing Great Reflation lies ahead. Therefore,
countries like China and India will also do investors, as we have emphasized before, must
well, but as valuations get stretched, volatility look for milestones to assess whether
will increase a lot. Good entry points are underlying conditions are changing. The most
Japan. The lesson there is not very consoling. 3. Corporate credit spreads
Japan never got past Act I - the avoidance of a 4. Credit defaults swaps on sovereign debt
about restoring equilibrium and returning to We have added the last one to our
sustainable, non-inflationary growth. Japan has previous list because credit rating agencies are
had less than 1% real growth for 20 years even getting nervous and are still licking their
with zero interest rates. Lack of growth has wounds after their catastrophic performance
pushed the debt to GDP ratio close to 200%. prior to the crash of 2008. There are, of course,
Forget an easy solution; there does not seem to a variety of other milestones to watch which
be any solution and ultimately there will be a we will be monitoring. For the time being, we
yen collapse and a sharp rise in interest rates don't see any significant signs that the
that will cause havoc with government debt. liquidity-driven improvement in asset markets
However, the U.S. is not Japan; there won't continue into 2010. But remember, this is
are many differences which we will explore in a risky, uncertain world; you should carry
another letter. The point is that the U.S. is more liquidity than normal, be more risk
experimenting with the unknown. Act II of the averse if you are not in a position to recoup
WWW.BOECKHINVESTMENTLETTER.COM 6
THE
© BOECKH INVESTMENT LETTER
WWW.BOECKHINVESTMENTLETTER.COM 7
THE
© BOECKH INVESTMENT LETTER
Stocks
Commodities
Currencies
Interest Rates