Delete Bubble, Insert Deflation
Consensus opinion circa 1999: There is no bubble!
Consensus opinion today: There is no deflation!
The “consensus” is safe. Consensus thinking keeps a strategist from standing out. The consensus gives investors a false sense of security. Consensus thinking is what is wrong with Wall Street research.
Wall Street firms spend millions upon millions to come up with research that is virtually the same thing as everybody else’s on the Street. This is “the consensus.” It means if your research is wrong, so is everybody else’s and you keep your job. The worst that can happen to you is that you have to re-adjust your numbers and predictions, along with everybody else – and live to predict again.
If you stand out and make bold predictions, and are wrong, you could find yourself doing actuarial work for a small insurance company. So Wall Street doesn’t have many strategists and analysts that are willing to stick their necks out regarding any controversial subjects.
Yesterday it was the market bubble. Wall Street consensus said there was no bubble. Throughout the late 90’s, as warnings from fringe analysts got louder and louder, Wall Street did a good job of ignoring and even ridiculing these unconventional voices. Even when there were irrefutable facts in front of them, Wall Street did its best to ignore the obvious.
Who has had the last laugh? Unconventional thinking saw what consensus thinking could not. Now the consensus says there was a bubble (but are in agreement that it is a thing of the past). How many strategists were fired over the past couple of years for missing the bubble and costing investors trillions? Not one.
Today the controversial subject is deflation. Although there is a mountain of evidence of deflation, consensus thinking views deflation as only a remote possibility in the future. The consensus believes it is definitely not here today and very little chance of it arriving anytime soon.
But industry after industry is having its second, if not third year of deteriorating pricing power. Few industries have the ability to raise prices and most are seeing pricing pressure from sources as diverse as overseas competition and the Internet. But the consensus says this isn’t deflation.
The PPI (Producer Price Index) has had a cumulative negative number for the past 12 months, but this isn’t deflationary either.
Profits are under pressure virtually everywhere, but this isn’t deflation. Revenues are barely holding flat at many companies, but this isn’t deflation.
Consensus thinking views deflation as continuous price declines with an associated collapse of the economy. This doesn’t have to be the case though. Japan from 1989 to the present is the perfect example. Deflation there has lasted twelve years. Japan has seen lower prices, but no collapse of the economy, yet.
Actually, deflation has stages. The first part is profit deflation. This is where profits come under pressure during a period of what should be good economic times. The economy keeps growing, yet profits seem to stall or even decline. We have seen this at both the macro and micro levels for the past few years.
The next stage is revenue deflation. This is where revenue streams seem to slow or even decline. We have seen this in the telecoms and internets especially. In the retailers it is seen in same store sales.
The last stage of deflation is all-out and continuous price declines. This only happens when the consumer decides to close up their pocketbooks and wallets. Desperate to attract business, companies drop prices with only one objective in mind – cash flow.
Does any of this sound familiar? Of course it does. It is what the economy is experiencing right now. Various industries are at different stages. Many industries are in the middle of profit and revenue deflation and some industries, but not many (computers, equipment, telecoms), are in price deflation.
But don’t tell Wall Street. They are still trying to figure out how they missed the biggest stock market bubble in the past 100 years. While they are figuring that out, they are missing what may well end up being the biggest deflationary cycle in the past 100 years.
But you can be sure, when it is over, the consensus will agree that we had a terrible deflationary cycle. The consensus will say it was obvious only after the fact, it couldn’t be predicted. And none of Wall Street’s strategists will lose their jobs.
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