Sunday, March 25, 2007

There has been a lot of talk about this next recession.

Maybe too much talk. Predicting a recession is very difficult in any environment, let alone one with two huge and rising stars (India and China). Over time, people that base their investment strategy on the constant belief that a recession is imminent will not perform as those that bet on growth. Doomsday preaching is more a personality characteristic than a sincere prediction. We get upset when someone that says things are about to melt down turns out to be right, the market drops 14% and then is stagnant for a year...but the truth is that same guy missed out on 10 years of groth at 9% a year to be right that once.

Predicting inflation is easier. I believe that since the early 80s inflation in the west has been low because we have imported more and more core products from low cost overseas producers every year while raw materials prices were also stable. In the last couple of years, there has been a huge and rapid rise in raw materials costs, and we already import almost all manufactured goods (there is no more cost savings to be had from increasing imports). Also, labor and production costs are starting to rise in China and India. Energy, which is a cost input to almost every product, is going to get more costly.

I am fairly certain that the Chinese economy is bubbling in a few areas, notably including real estate and public equity markets (the PEs are ridiculous and expect unsustainable growth, and in real estate the rental to price ratios are about half of what they are in the U.S.). I don't think their recession will spill over much to the U.S. when they correct, but it could cause them to draw down foreign reserves, which will flood the bond markets a bit - driving down bond prices, and driving up interest rates.

So long and short, no significant global recession is always the smarter bet, but you can expect higher inflation over the next 5-10 years. I am not comfortable predicting how much higher.

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