Big Picture Backdrop and a Surprise

With the market getting a much needed pause from despair I am concerned as to when we get the next reality check. Hopefully this bounce will provide room for portfolio adjustment as a bear market relief rally. You only find out who's been swimming naked when the tide goes out. Today the tide came in, but the analogy is apt since it will be going out again soon enough.

There is already evidence that the economy is retrenching as the credit bubble deflated. Household debt growth fell to 1.4% in August, the lowest on record. The next step will likely be a debt decline as the U.S. consumer retools to begin a rebuilding of national savings.

Federal nondefense, noninterst spending soared to a record 14.7% of the economy and the foreign holdings of U.S. debt exceeded 15% of total debt for the first time. Fundamentally sound? I bet Senator McCain would like that sound bite back.

A view I have held for a long time and over the years repeatedly been proven wrong is that the only way out of the debt will be inflationary. Perhaps this time I'll get it right with the U.S. government (taxpayer) on the hook for possibly over one trillion dollars.

The government needs to buy time to avoid a financial and credit freeze. Its move to consider establishing a fund to buy up to $800 Billion in "failed assets" on top of $400 Billion to prop up money market funds is serious stuff. Given time it is possible that a significant portion of these assets will be disposable at a level even profitable to the US taxpayer. That remains to be seen. There were rumors that Goldman Sachs tried unsuccessfully to find raise sufficient cash to buy such assets before the government moved in. Perhaps like the private purchase of Longterm Capital assets, this could actually provide some profit. More likely this will be a deal of less than the worst fears but still substantial cost to the taxpayer.

It will be necessary for the real estate market to stabilize and begin recovery to have any hope of these bail outs being less than disasterous.

Looking past the dark abyss, opportunities will likely lie in inflation sensitive asset classes and investors may want to take a deep breath and add a child's portion real estate back into the portfolio if no longer there. If it is in the governments interest to stop the collapse of real estate you can bet they will be making a mighty effort to do so. As Collin Powell once said, "you break it, you bought it."
Come January a new administration will get a chance to see if they are any better at fixing broken things.

John Barnyak
President