2 September 2009
Prepare for the next leg in the Ice Age journey into deflation
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Global asset allocation
Equities 30-806035Bonds 20-503550Cash 0-30515
Source: SG Global Strategy
Very OverweightOverweightUSUKNeutral Cont EuropeUnderweightJapanEmerging mktsVery Underweight
Source: SG Global Strategy
IMPORTANT: PLEASE READDISCLOSURES AND DISCLAIMERSBEGINNING ON PAGE 4
Commentators have been perplexed by recent strength in government bond markets,especially set beside continued resilience in equities. They should not be. The bond market isresponding to two key events. First, it is clear to us the ongoing march into
deflationwill accelerate during this short-lived economic recovery. Second, post-bubble realities willforce commercial banks to aggressively step up their buying of government bonds.
Recent weeks have seen commentators either busy throwing in their towels, as theequity bull market has marched resolutely upwards and onwards (maybe that will changeafter Monday), or wrestling with their conundrums. Many have found the robustness ingovernment bond prices through August most perplexing, especially when set besidecontinued resilience in developed equity markets.
Once again, equity participants are missing the big picture. For despite clear signs fromthe business surveys of some sort of H2 recovery, firm evidence is emerging that the globaleconomy is sliding towards a full-blown deflationary episode once this recovery falters.
My former colleague Rob Parenteau pointed out something interesting to me the otherday. He noted the huge divergence between US economy-wide inflation as measured by thegross domestic product (GDP) deflator and a slight variant of GDP, the deflator for grossdomestic
(see chart below). The key definitional difference between the twomeasures is that the latter includes recent savage import deflation (as GDP includes exportsand
imports). Hence the gross domestic purchases deflator is a better measure ofwhat is going on in the US
economy. With import prices down some 19% yoy andeven a record 7.3% yoy if one excludes petroleum, no wonder the price of domesticpurchases has already fallen into deflation. If anything, domestic purchases inflation leadstrends in both GDP and core CPI, so this is significant news. (
For those who have never come across Rob Parenteau, I believe he is one of the best and bravest commentators out there. His printed thoughts can be found in the renowned Richebächer Letter – link .)
US GDP measure of inflation lags domestic purchases inflation…or is that deflation?
90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08-1012345-1012345
gross domestic purchasesgross domestic product (GDP)