Permanently High Plateau

Hoisington Management advises the excellent Wasatch-Hoisington U.S. Treasury fund (WHOSX), which I have held from time to time. The only reason I don’t hold it right now is that I have chosen to hold U.S. Treasuries directly rather than through the fund, obviously saving the fund fees but of course paying the broker’s spread instead. This is because I anticipate that I will be holding the trade for quite some time. They publish a quarterly report which is always worth reading, but the most recent is especially relevant. Written by Lacy Hunt, and entitled “Three Competing Theories,” it identifies the fatal flaws in the models that are driving the destructive actions of politicians and the Fed, and recalls the post-Depression work of Irving Fisher.

The Fisherian theory is that an excessive buildup of debt relative to GDP is the key factor in causing major contractions, as opposed to the typical business cycle slumps. Only a time consuming and difficult process of deleveraging corrects this economic circumstance. Symptoms of the excessive indebtedness are: weakness in aggregate demand; slow money growth; falling velocity; sustained underperformance of the labor markets; low levels of confidence; and possibly even a decline in the birth rate and household formation. In other words, the normal business cycle models of the Keynesian and Friedmanite theories are overwhelmed in such extreme, overindebted situations.

Sounds about right. What Ms. Hunt’s report doesn’t mention is that Irving Fisher is the unfortunate gentleman who, three days before the 1929 crash, publicly opined that the stock market had reached “a permanently high plateau.” As a result of this colossal error in judgment, he lost credibility and his analysis was drowned out by the Keynesian chorus.

On a day like today, when the momentum monkeys are charging in to buy stocks despite a dismal fundamental and economic picture, it is worth recalling how the siren song of 1929’s bull market lured investors to their ruin. Many may think that we have avoided a depression, courtesy of the Fed and Nancy Pelosi, and it is safe to invest in a “recovery.” They are wrong. The 2011 market, locked in a quite narrow trading range, gives the appearance of a “plateau” once again. I think there is a very real possibility that we are peaking here, or at least in the next month or so, and will see a fall panic. All the elements are in place for another financial panic, this time involving sovereign debt as well as the still-festering remains of the housing bubble.

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