First, Happy Easter Week to you and yours.

Second, our thoughts and prayers go out to all those in Brussels who have been affected by the latest terror attacks hitting the headlines in the last hour or two.

To Reviews

Before we get to a few insights I wanted to share, let’s review a couple of quick headlines which may be helpful on future setbacks:

This is a headline just out of BAML (Bank America Merrill Lynch) which shows that investors continued to be net sellers of stocks for the 10th straight week. The only other time which was longer? Two – March of 2009 and later in 2010, both being pretty good times to buy the fear in retrospect, yes?

The takeaway of course is that there remains a deep-seeded set of fears that almost anything will ignite. I have said it before – but it bears repeating: The 2008/2009 financial setbacks were this generations’ Great Depression. I recall meeting clients in the 80’s who had lived through the Great Depression and it still impacted their perspectives decades later.

The data continue to suggest the same is unfolding in the minds of some investors today. Even as we watch the market have its best quarterly recovery in 8 decades. That is not an accident.

Inflation or Deflation?

In a few of your most recent notes we suggested that while the entire world has now become focused and “educated” on the perils of deflation, we may want to start looking for the whiff of inflation. Before you have a seizure – inflation would be a great thing…surely better than deflation. The chart below helps a bit:

The chart above shows the year-over-year change in the CPI (total) and the CPI ex-energy. Note how much more volatile the total is compared to the ex-energy version. Note also how the most recent period, during which oil prices have collapsed – is similar to the 1986-87 period, when oil prices fell about as much in percentage terms as they have in the past 22 months.

In both periods, the total CPI suffered a significant decline followed by a significant rebound, while the ex-energy version was relatively unchanged. There is every reason to believe that the headline (total) CPI will register 2% year-over-year growth (if not more) within the foreseeable future, since oil prices are no longer declining and have even rebounded some 40% in the past month or so. In fact, the latest data are beginning to show just that….again, nothing to fear.


Check the red line on the chart and block everything else out. Notice that it has traveled within the same general band – a few ups and a few downs – since the mid-to-late 90’s! All the fretting and angst – was, well, wasted. One was far better off looking for good companies selling at decent prices….even as everyone else fretted over the end of the world.

The data in the chart above and most recent reports on the topic are entirely consistent with the behavior of the CPI, since the PCE deflator tends to register about 30-40 bps less than the CPI.

What this means is that the Fed’s preferred inflation gauge will soon be very close to the top end of its 1-2% target range.

The Lesson Here?

While the experts have been suggesting we vote for no rate increases from the Fed…the economy is actually recovering its pricing power. The upshot? Soon, the same experts will be telling us the Fed is doing too little too late.

Do yourself a favor – ignore the fear-mongering.

Forget economics for a moment friends. Think demographics. We are in great shape and the future is bright.

All That Debt

A quick Econ-101 lesson is in order to defuse this rampant fear about companies borrowing too much money.

First, yes, of course, un-managed, inappropriate borrowing is not productive and can indeed lead to failure and bankruptcy when unable to repay.

However, in a world so full of fear that the demand for debt allows markets to stay at record low rates, a CFO is compelled to always look for better used of capital. If my business earns 10% on its equity and I can borrow at 4% for 15 years, I am often a fool if I do not try to strategically borrow to buy back and retire my stock – especially when the same environment of fear causes my stock price to be lower than it likely should be.

The Flip Side

Be assured, there will be a flip-side to this coin. And here is how it unfolds.

Later, years down the road, all these borrowing programs to buy back stock will come due – right? Scary huh? It shouldn’t be because here are the options.

If things have indeed improved – excellent. The same CFO position will then recommend a sale of the same stock they bought back lower years earlier in order to retire the debt. The perception then will have changed and the market environment will applaud the reduction of debt, the improving balance sheet and the “firepower” to borrow again in the future.

If things have NOT improved, fear can be expected to still be rampant and deep-seeded – hence, rates will be low for refi’s needed.

Now I am not suggesting that all details will work this way but this has been the process for many decades as rates ebb and flow.

Equity and debt are always in a dance.

Understand the dance – don’t fear it.