Be Prepared! What if Things Go Right?

Though the US equity market seems short-term overbought, I want to poke at an area of the investment space that is more bearish than me.  Though I admit there are many problems in the world today, investment is still a question of buying assets that will deliver the greatest amount of purchasing power over time.

And though I don’t think the equity premium is high on average, I certainly prefer stocks to bonds here.  Cash is another matter — I could see both stocks and bonds decline over the next year, though that is not my default scenario.  Commodities are tougher, and I don’t have a strong opinion.

But I could be wrong in a wide number of ways.  If one looked at my personal asset allocation, it would look something like this:

  • House 15%
  • Private equity/debt 12% (I’m an angel on the side?  Well, sort of.  I help close friends.  The debt was in my opinion junk grade, and now investment grade.)
  • Cash 10%
  • TIPS 3%
  • Public equities 60%

That doesn’t look so bearish.  Part of my operating philosophy is that over time, things do tend to go right, but not all of the time.  Great Depressions are normal events, not abnormal events.  They occur because we have a debt-fueled expansion in some major asset that is a temporarily virtuous cycle, until players begin relying on capital gains to keep their position financed.  That doesn’t happen, and the asset bubble begins to unwind leading to debt problems.

At present, we are part way through the debt crisis.  The banks aren’t in great shape yet; I still think that their assets may be overstated on their balance sheets.  It remains to be seen whether the banking crisis will turn into  a sovereign crisis.  In the Eurozone, it may be worse.  The mechanisms they are trying to set up are trying to defuse the risks of Eur0fringe credits to Eurocore banks.  Cheaper for Eurocore governments to discourage lending to the Eurofringe, much as that cuts against the concept of a common market.

The debt crisis is not over; it is morphing into a sovereign crisis, aid by the growing unfunded liabilities from government pensions and healthcare.

At present I see professionals bullish on stocks, and bearish on bonds.  They are expecting that GDP growth will pick up, and inflation be moderate.

I think stagflation is a real possibility, with inflation and unemployment rising. That would be bearish for bonds, and less so for stocks.

But back to my original point. I don’t have simply one estimate of where things are going, I have many estimates, and it is quite possible that things go right.  Governments and policy makers have an interest in making sure things go right, so it is not airy fairy to presume that the present condition will continue, even if real growth slows.

A great trouble with a dynamic economy is that it is not possible to compare eras, because the underlying structures of each era changes.

And so at present I muddle in the middle, investing on the low side of bullishness.

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About David Merkel 145 Articles

Affiliation: Finacorp Securities

David J. Merkel, CFA, FSA — From 2003-2007, I was a leading commentator at the excellent investment website ( Back in 2003, after several years of correspondence, James Cramer invited me to write for the site, and now I write for RealMoney on equity and bond portfolio management, macroeconomics, derivatives, quantitative strategies, insurance issues, corporate governance, etc. My specialty is looking at the interlinkages in the markets in order to understand individual markets better. I still contribute to RealMoney, but I have scaled it back because my work duties have gotten larger, and I began this blog to develop a distinct voice with a wider distribution. After one year of operation, I believe I have achieved that.

In 2008, I became the Chief Economist and Director of Research of Finacorp Securities. Until 2007, I was a senior investment analyst at Hovde Capital, responsible for analysis and valuation of investment opportunities for the FIP funds, particularly of companies in the insurance industry. I also managed the internal profit sharing and charitable endowment monies of the firm.

Prior to joining Hovde in 2003, I managed corporate bonds for Dwight Asset Management. In 1998, I joined the Mount Washington Investment Group as the Mortgage Bond and Asset Liability manager after working with Provident Mutual, AIG and Pacific Standard Life.

I hold bachelor’s and master’s degrees from Johns Hopkins University. In my spare time, I take care of our eight children with my wonderful wife Ruth.

Visit: The Aleph Blog

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