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So S&P downgraded the US one notch to AA+ with a ‘negative’ outlook. Given the downgrade, escalation in the debt limit and promised spending cuts spread over the next decade; one would be forgiven for thinking Treasuries would have sold off with money flowing into safe-haven favourites (CHF, JPY, Gold..). Treasuries rallied reacting to this news, showing that in times of duress, psychology trumps everything else as investors pile into an asset class for its perceived safety value. Never mind if the expected return is not commensurate with the risk assumed. Actually, few think in terms of 'return' when it is apocalypse time. Treasury rally in the face of a downgrade also indicates that few probably believe in the rating agencies' opinions. With the Swiss bank slashing rates to curb the CHF's rise and the BoJ intervening to prevent a rise in the JPY, the world resembles the stage in the 1930s when everyone scampered to be the first to hit the currency bottom in a bid to boost exports. 

Given the above, it looks likely that Monday market open will be greeted with $ weakening, more Treasury buying, and money flow into Gold, the ultimate (perceived) safe-haven. Disclosure: Long yellow metal.

Stepping back a bit and looking at the globe as a developed/emerging markets matrix, one observes:

1) The developed world struggling with solvency and liquidity issues, with politics upstaging economics by a huge margin. The politics trade is a tricky one, giving few asset classes or trading themes time to take shape. Growth continues to be anaemic while inflation seems just a corner away from ambush. The devil is on leash for now but for how much longer? The path of least resistance seems to be a period of stolid economic growth amidst a backdrop of low-to-moderate inflation. Stagflation = +1.

2) The emerging world is grappling with a central banker's ultimate nemesis; above-target inflation and below-trend (and slowing) economic growth. The path of least resistance here too, like the developed world, seems to be a period of stagflation. Stagflation = +2.

Lessons from history are a little dodgy here. The (anti-inflationary) Gold Standard was still in vogue in the 30s, so inflation wasn't an issue for economies till they defected or were forced to defect from the Gold Standard. Economic growth took a knock collectively but inflation did not pose as much a threat as a collective issue as it does now.

Given this central hypothesis of stagflation, hard-asset plays and businesses with annuity characteristics with some degree of freedom to raise prices without a corresponding increase in cost, are themes worthy of consideration. In a period of anaemic growth, investors have historically not been loath to paying a premium for sustainable growth, explaining lofty valuations of some of the consumer plays like Nestle, Colgate, Gillette, P&G. As long as the central hypothesis holds, these consumer plays will continue to blink on investor radars, high valuations notwithstanding. Another theme is companies with strong balance sheets and low dividend-payout ratios. Cigarettes, toll-roads, water/waste-water treatment, sections of the natural gas value chain, battery makers...The fixed-income asset class provides some interesting plays, given the high interest rate environment, by way of NCDs that offer an attractive risk-reward in senior pieces of the capital structure.

The Phoenix bursts into flames before perishing, followed by a rise-from-the ashes moment. Though the flames aren’t visible yet, a burning smell wafts into my nostrils.



SEV said…
You lost me in the last para. I get the attractiveness/potential of the fixed income asset class, but not much else that you talked about there.
Its getting to be a scary world.
HaLin said…
The last paragraph was on businesses that I'm eyeing that will stay afloat in a scary world.

But, very interesting times ahead. Something you'll remember after a few decades.

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