The subject matter of Today's blog is
Are we in for a suprise? In a World Full of Surprises the Double-Dip is no Surprise…at least to Friends of Kassius.
At the turn of the year we suggested that government bond markets may well unfold as the major source of financial anguish in 2010; as we reach the half way mark we take little joy in the correctness of our analysis. Recall the basic scenario - throughout the developed world we have witnessed a secular growth in the amount of debt relative to national output over the last 20 or so years; this has been mainly consumer debt in many countries. The idea that in some way the consumer debt can be ‘replaced’ by the government activities funded by debt leaving the whole financial system somehow in a better place is farfetched and repeated by the media picking and choosing from the writings of economists with no knowledge of financial history. We now have a far greater pile of debt to consider while analysing the economy; the word ‘replacing’ is totally incorrect.
(Source: http://www.usoge.gov/training/module_files/oge450_wbt_06/debt.gif)
The consumer is fatigued and has not saved at all at various times over the last decade in the US and UK; to reduce the burden of consumer overindebtedness requires a multi-year workout with reduced consumption, which, you may recall, is 60-70% of final demand in these economies. This is a very slow process unless we have wage inflation or debt forgiveness. One could argue that the Bank of England is sneaking in some RPI inflation and the bond vigilantes are being distracted by the World Cup and Wimbledon. Certainly the sterling decline is a subtle default for foreign investors. President Obama has encouraged debt forgiveness (reductions) for distressed home-owners; this is difficult to implement and has only partial success since 64% of those forgiven default on other debt (eg car loans) within a year.
(Source:http://jeffreyhill.typepad.com/.a/6a00d8341d417153ef010536c55fae970c-800wi)
Neither inflation nor forgiveness is likely at present; government bond markets are signalling default not inflation risk as it becomes apparent that the whole financial system is clogged up by excessive debt which cannot be serviced at ‘normal’ interest rates - and the mountain is set to explode further, especially in the UK. There will be quarters of decent retail or investment spending followed by negative surprises. Throughout the world demand will be sluggish; witness a slowing China this week. We see no possibility of sustained ‘healthy’ growth without debt destruction - think Japan for the last 20 years. Wage deflation is very bad news for this environment - think Southern Europe and Ireland; and how many analysts realise that 28% of employed US workers are working reduced hours, while 23% have had their pay cut? This all suggests a prolonged period of subdued growth - the fiscal and monetary nuclear experience cannot buy success in an overindebted world - see the chart on US monetary growth, a serious pointer to a subdued economy.
Double-dip may only be a prelude to multi-dip. This is a very difficult investment environment and the only message is to avoid big concentrated directional bets unless you are happy to lose. Casino investment should give way to thoughtful diversification.
(Source: Hasley Investment Management LLP. June 2010)
Chirag ShahDirector,
Kassius Ltd 
