Saturday, September 26, 2009

If you are bearish...

I believe that the Deleverage Process, the self reinforcing cycle of deleveraging or credit contraction, is the cornerstone of the bearish viewpoint. I also believe that attitudes towards home ownership and credit have changed, and the change is long term, not merely cyclical. As evidence that the D-Process is still running its course, consumers saw a record $20 billion of outstanding credit evaporate in August.

The above chart shows that the the private sector has deleveraged (reduced credit/debt) by over $6 trillion since 2006. Meanwhile the government has injected nearly $2 trillion of liquidity through with the help of the Fed's new credit facilities. Basically, the government is printing money like mad, hoping to forestall or at least moderate the destruction of our economy's capital base and prevent an all-out economic death spiral. Until the D-Process runs its course and we see a return to the virtuous cycle of credit formation in the private sector, I believe that the Fed will be more concerned with deflation than inflation. Inflation is a "problem" but deflation would be a full blown crisis.

For more on the D-Process, see this article by Ray Dalio, "Recession? No, It's a D-process, and It Will Be Long"

Ray Dalio of Bridgewater has done a better job than almost anyone of describing the current debt deleveraging process, and how it will play out. This Barron’s article contains a lengthy interview with Dalio, and it is a must-read as he describes the dynamic that has been underway in our markets.

Rather than base our investments on predictions, the Strategic Growth Model will continue to align its capital with the current market conditions, profiting from the statistical edge the system provides over the intermediate timeframe. For now, the market trend is UP.

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