Happy days are not here again, Hans Black

Looking forward. De-leveraging and lower prices will be name of the game for a long while

( Montreal Gazette) It is now January and a new year has finally arrived. I am probably joined by most of the planet in expressing relief that 2008 is now behind us. In a period of 12 months, more than $30 trillion of global equity valuation was wiped out, a loss of approximately 50 per cent.
In addition, we have witnessed the most intense series of bank failures since the 1930s. Indeed, the weeks of September and October can only be described in retrospect as a global run on the banking system.
We have also witnessed the largest bankruptcies in history and the virtual disappearance of the investment banking model that has been with us for many decades.
And that is just the beginning.
A more complete report would also include terrorism in India, a new war in the Middle East, along with the discovery in late 2008 of the greatest Ponzi scheme ever devised. The only thing missing seems to be the bubonic plague or some other medical disaster. For the moment, gone is the complacency that was the hallmark of many investors’ attitudes over the past decade, the constant clamouring for more returns and higher yields which seems to be over for a while as, unfortunately, most investors are looking at 40 or 50 per cent losses in their equity portfolios.
If we assume, for a moment, that the losses in debt and real estate portfolios are roughly $15 trillion each, then the total losses for 2008 of $60 trillion are in fact greater than global GDP for the year and a number which clearly needs further comment.
These numbers are unprecedented and quickly explain the very real sense of panic that engulfed so many politicians during many of the key weeks during October and November. In a matter of days programs in order to bail out banks and now re-stimulate the economy have been announced by most G10 nations.
An important component of the response by major governments in both the developed and developing world will also include zero interest rate policies which were used with moderate success in Japan in the late 1990s and are now clearly in evidence in a growing number of world economies. More importantly, the United States, in an historic series of decisions in December, has indicated to the world that they will closely follow such a policy and engage in QE – quantitative easing – to the extent necessary.
In the United States treasury bills, which currently yield virtually nothing, demonstrate the reality of a zero interest rate policy.
Yet, to those investors who have lost money and have decided, perhaps too late, to now be very careful, treasuries seem to be the way to go. Good dividend paying stocks are, of course, an alternative – but investors who have lost 50 per cent or more of their net worth are hardly in the mood to risk anything else and, for the moment, that explains why treasuries are such low yielding instruments.
In summary, investors all over the world have had their first serious whiff of deflation since the 1930s and all participants, central banks, institutional investors and governments are scared.
The policy responses that we are now seeing will likely provide a better environment for the next half year. The longer term difficulties that 2008 has exposed in our financial system are not disappearing.
The key word is de-leveraging as household balance sheets in the G10 will likely lead a global move toward de-leveraging in the years ahead. As has been stated many times, we will all return to much more frugal lifestyles.
Borrowing money from home equity in order to finance consumer needs is over and it is not coming back. Having 10 or 20 credit cards is probably also over and likely to go the way of the dodo bird.
For a while politicians will applaud the rebuilding of savings and, of course, who can argue with frugality. Unfortunately, there will come a time as we have seen in Japan where governments will beg people to spend, as politicians discover “the paradox of thrift.” Keynes in the 1930s went to long lengths in order to convince policy makers at the time that too much thrift was hurting the economy. The negative effect of rebuilding savings on output is probably a lesson that we will all be revisiting in the next few years.
Our economy, built on the stilts of consumption for so many years, will undergo a painful adjustment period. Ultimately, politicians will discover that they were the ones being hurt the most as tax revenues are so heavily dependent on that consumption. Having built up the systems to tax the very kind of behavior that kept providing dividends for politicians, we will soon need to literally reinvent the tax system.
For the moment, it is becoming painfully obvious that the very large and encompassing areas of credit, banking and many areas of consumption are simply not the place to be as an investor).
Despite the almost weekly refrain that the consumer is coming back, we simply doubt that this is the case. In time, 2009 will likely emerge as a year with tremendous volatility and lots of false starts but ultimately, unfortunately for many sectors, lower prices.
We remain, however, keen buyers of selective stocks that have worked so well for us over the past two years, namely health care, biotech, gold, select technology, and in recent weeks we have begun to re-accumulate positions in energy and certain types of commodities.
Some of these sectors should have stellar performances in 2009.
Hans Black is the chairman of Montreal investment management firm Interinvest Corp.