Buffett goes into shares – has he discounted stagflation?

As mentioned in a previous post, all the ingredients are there to create a pretty noxious soup of inflation and low or negative growth.

Stagflation is a rare occurrence and I believe that the 70s is the only time it has occurred in modern times. It is rare because a recession is usually accompanied by a reduction in demand which in turn will reduce pressure on prices. This is well-known and accepted.

Because wages are not increasing, unemployment is rising and consumers are reducing debt there is expected to be a reduction in overall demand. Accompanying this is a dramatic fall-off in investment and a rise in the costs of imports. If supply in the economy falls faster and further than demand then we have a recipe for stagflation. As to this the inflationary pressures of massive injections of cash into the economy and the stage is set for inflation to rise next year while the economy shrinks.

This may provide the basis for an interesting couple of years of inflation over 5% and growth either negative or close to zero. Are equities the best place for your money in times of stagflation? Cash is certainly not an option. Being a creditor is preferable. The problem remains though, where does an investor place cash? Buffett’s response seems to fit all scenarios. Can we expect therefore that cash will chase equities up rapidly well before we see the end of the current bust?

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1 Response so far »

  1. 1

    Darin Oliver said,

    Interesting view….I have been trying to see a scenario for stagflation in a world were wages are likely to fall as unemployment rises. In the 70s you had rising wages and rising commodity prices due to combination of powerful unions, a labor shortage and the OPEC oil shock. Today you have falling demand, certain asset prices collapsing (real estate and equities), rising unemployment all capped by highly inflationary actions by the Treasury and the FED have you seen : (http://research.stlouisfed.org/fred2/fredgraph?chart_type=line&s%5B1%5D%5Bid%5D=AMBSL&s%5B1%5D%5Btransformation%5D=pc1)
    And then we have real possibly catastrophe that could be building in China – decades of 10% growth and everyone believing that could go on forever – fueled by bad fiscal policy, an undervalued currency and foreign reserves created by reserve investment from western corporations whose sole desire was to export back to there own countries. If the China miracle unwinds as it is happening (how many times this year have economic forecasts for growth fallen there). The fact that inflation in China is dropping like a stone is a far more scary thing then in the US. They were real wage pressures building there and its all coming undone in a blink. They have a lot of reserves, but some people estimate that there bad loan problem exceeds them – and they depend heavily on foreign currency created from multinational corporations relocating there for re-export to the West – that’s grinding to a halt. But this inst a China post, although it does show how symptomatic the global situation is in.

    So, your theory about supply falling faster then demand is an interesting one. Still, 5% inflation isn’t serious and might be healthy under the circumstances but it would be a big surprise to the markets that are telling use deflation is the real enemy. Right now the FED and Treasury are printing money, but wealth is being destroyed at a greater rate – its the banks that really create money through the money multiplier – if they are not lending because there reserves are being wiped out from bad loans, then our economy isn’t going to grow and its going to be hard for inflation to make is way into the real economy (unless we can somehow get people spending faster and get money moving).

    Personally I think corporate bonds, especially high yield and possibly some distressed are safer plays then equity, as the FED is doing specific things to affect these markets.


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