Month: July 2009

Had a post from “Davidson” yesterday regarding inflation and bond vs equity returns. It illicited several responses on twitter that many folks, contrary to the results of the post would rather own equities in an inflationary environment than bonds.

True, and not. It goes to degree. In a low inflationary environment, asset inflation favors equities at the expense of fixed income bonds. BUT, as the post yesterday demonstrated, in times of “hyper-inflation” ie: The 1970’s, inflation’s destructive effect systematically reduces equity values, making the fixed income bond and its guaranteed return of principle more valuable.

My fried on twitter @zippertheory provided the following statistics:

Of the he stated:

As you suspected stocks get crushed in hyper inflation due to P/E compression (as you know discount rate increases dramatically killing all terminal values). I can only presume that if CPI is above 7% commodities/Gold and anything that resembles a natural resource would flying.

I’ve as included a handy chart from the book Unexpected Returns by Easterling that better illustrates my aforementioned point.

The chart (click to enlarge):

So the evidence is pretty clear that 4% inflation seems to be the magic number at which a weighting from equities to bonds ought to take place in one portfolio. The question then remains to be answered, “what effect will the unprecedented monetary expansion have on inflation”?

If you believe it will cause hyper inflation, it it time to begin researching bonds. With corp. bonds currently yielding 7% to 9% for very safe companies, it does put pressure on the return you need from equities when you consider the additional risk.

Note: A bond/stock hybrid can be also accomplished with high dividend paying stocks, for instance, a stock yielding 4% need only appreciate 3% to 5% to equate to the bond yields. Just make sure the dividends are safe….we have had a score of cuts the last year although it would seem the worst of them has passed

Personally I find it hard to believe the actions taken recently leave us with the rather benign 2% long term inflation rate the Fed predicted yesterday. It doesn’t match up with history.

That being said, for me it looks like 2%+ which means down the road I am going to be looking at some bonds….

Disclosure (“none” means no position):

“Davidson” submits:

First Read the following story from the WSJ:

China’s Iron Hand Comes Up Against Market

By CHUIN-WEI YAP

For China, there’s just seven points between national pride and market savvy.

Some of the bluest of China’s blue-chip steel mills have struck deals with major iron ore suppliers, accepting a provisional 33% cut to last year’s price.

This is the beginning of the end of an annual closed-door ritual that sets sale terms for one of the world’s most important industrial commodities.

This year, the negotiations have become particularly tortuous as China, the world’s biggest iron ore consumer, squared off with heavyweight miners, in hopes of getting a discount of 40%.

The acceptance of the smaller cut signals a fissure between the country’s steelmakers and the Chinese government, which together with the steel association heading the iron-ore price negotiations, has resisted any compromise.

The steelmakers say the latest deals are just temporary, and any difference will be refunded once China’s terms are set.

But their message is clear: Those who negotiated on their behalf miscalculated.

Analysts say the Chinese should have a struck a deal in February when the domestic economy was weak enough to warrant steeper discounts from miners. Steel prices in China have been rising for more than two months.

Certainly, Beijing’s decision to arrest four employees of the Anglo-Australian miner Rio Tinto hasn’t helped the country’s cause. The arrests are now widely accepted as linked to the iron ore price standoff.

As far as prices are concerned, Chinese officials are already softening their stance, saying they are willing to settle for a discount between 33% and 40%.

Now all the miners have to do is stand pat.

Craving certainty the Chinese market has spoken out — it is willing to settle for 33%.

Of the news, “Davidson” opines:

Free Market Continues to Take Control in China

This speaks volumes. The command economic tactic, i.e. dictated by political leaders, to negotiate iron ore discounts of 40% from suppliers has had to make way for the free market which dictated a 33% discount. Rather than following government guidelines the top steel makers seeing prices rise with world demand decided to take contract decisions back into their own sphere of influence and ignore the bureaucrats and the top down instruction.

This is what brings about democracy and free markets. That this happened in China speaks volumes as to the sea change which began in 1979 when Deng Xiaoping launched his economic reforms and continues. See the attached BusinessWeek article of September 27, 1999, “China’s New Capitalism”

BW 1999

Stories of single events such as this one which details the transfer of power from the political sphere to the free market have enormous impact to building free markets and democracy around the world for the long term.

For those who question the viability of the global economy, fear the future and the next bank failure, this report if read in the context of the BusinessWeek article should generate much enthusiasm for the future. When investing, I advise having both a “Top Down” and a “Bottom Up” methodology with the goal of grasping an understanding of as much of the global market as possible and with this the critical investment themes.

Disclosure (“none” means no position):

“Davidson” submits:

First Read the following story from the WSJ:

China’s Iron Hand Comes Up Against Market

By CHUIN-WEI YAP

For China, there’s just seven points between national pride and market savvy.

Some of the bluest of China’s blue-chip steel mills have struck deals with major iron ore suppliers, accepting a provisional 33% cut to last year’s price.

This is the beginning of the end of an annual closed-door ritual that sets sale terms for one of the world’s most important industrial commodities.

This year, the negotiations have become particularly tortuous as China, the world’s biggest iron ore consumer, squared off with heavyweight miners, in hopes of getting a discount of 40%.

The acceptance of the smaller cut signals a fissure between the country’s steelmakers and the Chinese government, which together with the steel association heading the iron-ore price negotiations, has resisted any compromise.

The steelmakers say the latest deals are just temporary, and any difference will be refunded once China’s terms are set.

But their message is clear: Those who negotiated on their behalf miscalculated.

Analysts say the Chinese should have a struck a deal in February when the domestic economy was weak enough to warrant steeper discounts from miners. Steel prices in China have been rising for more than two months.

Certainly, Beijing’s decision to arrest four employees of the Anglo-Australian miner Rio Tinto hasn’t helped the country’s cause. The arrests are now widely accepted as linked to the iron ore price standoff.

As far as prices are concerned, Chinese officials are already softening their stance, saying they are willing to settle for a discount between 33% and 40%.

Now all the miners have to do is stand pat.

Craving certainty the Chinese market has spoken out — it is willing to settle for 33%.

Of the news, “Davidson” opines:

Free Market Continues to Take Control in China

This speaks volumes. The command economic tactic, i.e. dictated by political leaders, to negotiate iron ore discounts of 40% from suppliers has had to make way for the free market which dictated a 33% discount. Rather than following government guidelines the top steel makers seeing prices rise with world demand decided to take contract decisions back into their own sphere of influence and ignore the bureaucrats and the top down instruction.

This is what brings about democracy and free markets. That this happened in China speaks volumes as to the sea change which began in 1979 when Deng Xiaoping launched his economic reforms and continues. See the attached BusinessWeek article of September 27, 1999, “China’s New Capitalism”

BW 1999

Stories of single events such as this one which details the transfer of power from the political sphere to the free market have enormous impact to building free markets and democracy around the world for the long term.

For those who question the viability of the global economy, fear the future and the next bank failure, this report if read in the context of the BusinessWeek article should generate much enthusiasm for the future. When investing, I advise having both a “Top Down” and a “Bottom Up” methodology with the goal of grasping an understanding of as much of the global market as possible and with this the critical investment themes.

Disclosure (“none” means no position):