Balance

I don't see too many imbalances in the system. Equities appear fairly valued. The economy appears to be getting back on track. I guess bonds are the obvious area of imbalance, both in terms of the amount of debt outstanding and the price paid for that debt.

Of course, balance is predicated upon confidence and if confidence evaporates, then balance disappears along with it (or at least adjusts to a lower equilibrium).

The accumulation of overweight (aka as imbalance) is greatest in the sovereign area. But so long as sovereign's can maintain confidence, they can continue to accumulate liabilities.

Look for market reverberations (like in the summer of 2007) for signs of disequilibrium. Japan is the most obvious candidate.

Until then, party like its 1999.

All Roads Lead to Inflation

At this point, all roads lead to inflation. This may be strange given that there are strong deflationary forces brought about by the deleveraging from a balance sheet recession still in the system.

But if you take a step back. The Fed is implicitly (if not explicitly) trying to create it. The third world is experiencing it. Risky asset prices are reflecting it. The markets are beginning to come around to it.

We're playing with fire here.

Most historical studies indicate that inflation is generally positive for risky assets, but too much inflation is bad. Hyperinflation is another thing all together, leading to the wipe out of an existing order/system. But even if we don't see hyperinflation, only inflation, there are assets that provide a better store of value than others. What inflation does is force you to do something. You can't just sit there (and especially not at the moment with cash and bond yields so low).

If it true that all roads lead to inflation, then how can investors best preserve their purchasing power? What stores of value will help protect investors against inflation? How should investors best approach this problem? Investors need to take greater risk with their asset allocation. Being fearful and leaving money in cash or bonds is perhaps the worst thing they can do.

Are Bond Economists Better Than Equity Economists?

Q. Is there a difference between bond economists and equity economists?
Ans. I doubt it. At least I suspect that would be the case if you did an empirical study of the question.

Having said that, why do I feel that bond economists tend to be more pessimistic and equity economists tend to be more optimistic?

Much, no doubt, has to do with the markets they are speaking to. We all want to hear, what we want to hear.