October 11, 2008

Credit crunch musings

I'm happy to reread some of my long-dormant blog. I was worried I had left little proof that I'ld been warning about the bad credit in the US...

The US started living on credit under Reagan. Things got out of control in the early nineties, because there was a feeling that there was no competition for the US system anymore. By 1996, 1997 the economy was well on its way to the stratosphere, with nothing holding it up but faith. This time it's different....

I think that most of what happened after 1996 was a zero sum game for the US, at best. The internet brought new jobs, and high paying ones, but it removed others. Globalisation increased profits in the US, but moved labour costs (income to others) out of the US.

Because of inflation, I figure that the US is 40% ahead of 1996. That means a GDP in the order of a little over 11 trillion. If that is correct, GDP will have to drop by about 3 trillion to get back to realistic values. A 20% drop in the calculated size of the economy is no longer an abnormal prediction. The DJIA would end up in the mid-8000.

So. Time to buy stocks? Not quite. the irrational exuberance that kicked off in the mid nineties ran more than 10 years. Betting on the economy going back to realistic valuations was a fool's game during that time. There's no reason to assume that the irrational pessimism will dissapate faster.

So I expect the market to be undervalued for years. Unfortunately, that brings us to the point where the boomers start to retire. At that point, increasing numbers of investors will structurally move out of growth stocks, to safer stocks, bonds and even more conservative income instruments. This extended and persistent money reallocation will start to weaken markets. As more boomers retire, it will become another selling pressure that will depress the markets.

Time to move into bonds? Well, if you're anywhere near retirement, duh. If you're not near retirement, it probably isn't worth the trouble. Just start allocating a lot of your new savings (you do save, do you?) to your bond funds...


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