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Poor retail sales and jobs data signal a deflationary shock of the sort that crashes financial markets

Posted on 12 January 2014 with no comments from readers

Only a month ago we published an article about the deflationary shock that Robert Napier, author of the ‘Anatomy of the Bear’ thinks is about to ‘reduce equity valuations from very high to very low levels’ (click here).

His book is an investment classic (buy here), the result of a lifetime of sober analysis and not from the armageddon school at all. He concludes from having studied many, many financial market crashes that the trigger is always the same:

‘Three times since 1997 inflation has fallen below one per cent with very negative impacts for equity investors,’ he explains. ‘On all three occasions an existing low level of inflation was forced lower by dramatic events: the bankruptcy of Russia and collapse of LTCM in 1998; the terrorist attacks of 11th September 2001; and the bankruptcy of Lehmans in September 2008′.

Massive bubble

What’s going to prick the current bubble? And let us not pretend with US stocks up 45 per cent in two years with record margin lending that this is anything else. Valuations have not been this extended since 1929.

Mr. Napier points to Asia as an exporter of deflation. Once inflation falls below one per cent a financial market crash is inevitable on his analysis. And how does Asia export inflation? Basically by dumping stuff on to already weak retail markets elsewhere in the world.

Christmas was a disaster for retailers this year. Your average consumer does not work on Wall Street and has shrinking disposable income. That’s deflation too. And when consumers can’t afford to buy stuff then retailers have to slash prices. That’s deflation.

Given that consumer spending accounts for 70 per cent of GDP in the US and many advanced countries this is a hugely significant development. It also helps to explain the appallingly low US jobs number last month. Retailers cut back on hiring. Less jobs mean less people spending and that is also deflationary. Labour market participation is at a record low.

New normal

So when does this new normal get reflected in stock market prices? Well have you not noticed that shares have been slipping since the start of the year. If Mr. Napier has called the bear correctly then this is the start of a new trend and markets could indeed fall from their current great height.

Wall Street bulls will reply that the Fed will save us by slowing down on tapering its QE program. They miss the point that the Fed has already lost the plot by raising interest rates since last May. We are only now feeling the impact of that action which has a six month time lag.

That was the fatal error. But remember that all bubbles always have to burst. This one has lasted long enough to bleed the shorts dry and silence the bears, and that is what you always see just before a bubble bursts.

Sure after a nasty deflation and ‘normalization’ of asset prices we would get money printing on a scale never imagined, and that would create the kind of monetary inflation that will drive silver and gold prices to the moon. But we will have to get there first.

Preparing for markets like these is not easy. Readers of the ArabianMoney investment newsletter (subcribe here) will have our best actionable advice and should survive in better shape than most.

Posted on 12 January 2014 Categories: Banking & Finance, Bond Markets, GCC Economics, GCC Stock Markets, Global Economics, Gold & Silver, Hedge Funds, Investment Gurus, Sovereign Wealth Funds, US Dollar, US Stocks

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