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Irrational Investors Buying into Deflation Scenario

Economics / Investing 2009 Feb 03, 2009 - 09:16 AM GMT

By: Oxbury_Research


Best Financial Markets Analysis ArticleGlory Days? As I write this article on Super Bowl Sunday morning, I am looking forward to both the football game and the half-time show by Bruce Springsteen. When I think of the Boss - Bruce Springsteen, I always think of his classic song called Glory Days .

Perhaps Glory Days should replace the Star Spangled Banner as our national anthem. Old Uncle Sam could reminisce about his glory days . Such as the days when our country did not have Treasury secretaries from Goldman Sachs or not have a system-gaming, new Treasury secretary appoint a Goldman Sachs lobbyist as his top aide.

Most Americans, however, continue to immerse themselves in past glories of the US. Politicians of both parties still proclaim the United States to be the richest nation on Earth. We used to be. Glory days . Are they not aware of the many trillions of dollars that our country owes to overseas investors? Are they not aware that, thanks to Wall Street and others, our debts are growing exponentially and will continue to do so for many years to come?

This year's summit in Davos has brought home another point. In prior years, Americans would go around beating their chest like a gorilla, telling everyone how great the US was. American officials, businessmen, and economists would lecture everyone on how the American economic model was the best. Americans would encourage everyone to adopt our model, to raise themselves to our level.

Most people around the globe used to agree that the American economic model was the best. They used to. Glory days . Now everyone around the world sees the American model as a sham, as a casino in which participants totally mismanaged risk while enriching themselves. They say that at least casino operators are honest enough to put the word CASINO on the entrance.

As part of the broken American model, American financial regulators are now seen globally as incompetent. People now think that Woody Allen's definition of a stock broker is true - that a broker is someone who invests your money until it is all gone! US regulators seemed to have become merely cheerleaders, rooting on Wall Street. “Here We Go, Stealers! Go Dick Fuld! Rah! Go John Thain! Rah! Go Stealers!”

Future Glory Days?

Will there be future glory days for America? We can always hope. Maybe President Obama can perform a miracle. Perhaps what needs to change most in America is the culture of “instant gratification”, especially on Wall Street.

The arrogance and sense of entitlement that pervades Wall Street needs to be pulled out by its roots. Yet, nearly 9 of every 10 of the most senior banking executives from 2006 are still on the job. Aren't these the same idiots who got us into the mess in the first place? And now they are expected to manage the taxpayer-funded multi-billion dollar bailout for us? Why haven't they been fired?

Taxpayers who were hoping that Wall Street would start showing some gratitude and humility for the billions of dollars they have received have been sorely disappointed. Wall Street fully expects government bailouts be the gift that keeps on giving and will keep looking for more and more taxpayer money with, of course, no strings attached.

This shows that there continues to be a major disconnect between the way Wall Street regards itself and the way Wall Street is regarded by the public. Few Wall Street bankers think that it is out of the ordinary that they are so much better off than most other members of society. They have come to expect that as a “right”. But why should employees of Wall Street banks be treated as members of some special privileged class?

Investor Psychology

What would be even nicer is if somehow we could change the psychology of the entire country, not just Wall Street, from instant gratification back to the glory days . Back to when people saved and invested more for the long-term. Now the “traders” mentality, as exemplified by Jim Cramer, pervades society and investors - “I don't want to make a million dollars in 10 years, I want to have it right now.”

I see the emphasis on short-term investing results all the time. Long-term “big picture” type of investors such as Jim Rogers or Mark Faber or Peter Schiff are often scoffed at and ridiculed. I constantly see comments like “He's an idiot - look at what his portfolio did this year or this quarter!”

Who cares about short-term performance? I sure don't. What I want to know is what an investor has done over longer-term time frames, such as the last 5 or 10 years. Real wealth is built by patient, long-term investing, not by day trading. Not exactly a recipe that most Americans embrace.

In my 20+ years experience in the investment business, I found there was one constant – human irrationality in making investing decisions. Most human beings see a short-term trend and they extrapolate that trend indefinitely into the future.

Daniel Kahneman, the psychologist who was awarded the Nobel prize for economics in 2002 for his work identifying systematic irrationalities in decision making, has spoken about the tendency for human beings to extrapolate current trends.

In fact, Professor Kahneman suggests that this tendency helped create the US housing bubble. In looking at real estate markets, such as California, he says “It takes very little time for people to perceive a trend and to assume that it goes forever.”

We are again seeing this type of investor behavior in the latest asset bubble. So-called investors keep piling into the already overcrowded deflation trade and purchasing zero percent Treasuries. These deflationists have seen the current trend, as emphasized again and again by the short-term trading capitol of the world – CNBC, and are extrapolating that trend infinitely into the future.

No one denies that we are seeing deflation right now caused by the liquidation of over-leveraged players in the financial markets. This trend may continue for several more months, perhaps a year at most. I don't know exactly when the deflation will end and I don't care.

What I do know is the that long-term trend is toward much higher inflation. The Federal Reserve has decided to head down the path of printing trillions of dollars of phony money as the easiest way to alleviate debt burdens. This money printing will lead to long-lasting inflation and a debasement of the US dollar.

There was an interesting quote from Martin Wolf in a recent issue of the Financial Times. He said, “If central banks and governments are aggressive enough, they CAN generate inflation.” Mr. Wolf went on to say, “But they will imperil – if not terminate – the experiment with unbacked fiat money that started in 1971.”

I don't know if future inflation will go that far but the point is that because inflation is not the current trend and deflation is, most so-called investors are only extrapolating the current deflationary trend indefinitely into the future. That is why the US government TIPS market is saying that we will have deflation for the next 30 years.

I believe that the current deflation scenario is a perfect example of investor irrationality. Any investor who is looking for glory days in his future should try to take advantage of this irrationality, by going against the short-term trading crowd and accumulating positions in TIPS directly and by purchasing some commodities.

However, I'm sure that most so-called investors will ridicule my thoughts and continue to focus on short-term, CNBC time horizon type of trends. How I long for the glory days without CNBC.......


By Tony D'Altorio

Analyst, Oxbury Research

Tony worked for more than 20 years in the investment business. Most of those years were spent with Charles Schwab & Co., both as a broker and as a trading supervisor. As a supervisor, he oversaw, at times, dozens of employees. Tony was trading supervisor during the great crash of 1987 and was responsible for millions of dollars of customers' orders.

Oxbury Research originally formed as an underground investment club, Oxbury Publishing is comprised of a wide variety of Wall Street professionals - from equity analysts to futures floor traders – all independent thinkers and all capital market veterans.

© 2009 Copyright Nick Thomas / Oxbury Research - All Rights Reserved
Disclaimer: The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. Information and analysis above are derived from sources and utilising methods believed to be reliable, but we cannot accept responsibility for any losses you may incur as a result of this analysis. Individuals should consult with their personal financial advisors.

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