Sunday, April 26, 2009

Is inflation the key to the market rally?

The UK government budget unveiled on Wednesday of last week left me speechless. It wasn't so much the massaged numbers and overly optimistic growth forecasts that alarmed me. Rather, it was the singular lack of urgency in attacking the imbalances. Any self respecting company that found that its fixed costs were clocking up to a rate of 125% of revenues would have quickly wielded the axe to overheads. However, UK plc seems to think that it can wait for three years before starting to trim expenditures. Government supporters will say that now is not the time to reduce demand by cutting back on expenditures. That's true. However, what we are then saying is that as most of the UK's borrowings are denominated in sterling the government will fund this gap by printing money - thereby sparing the taxpayer from shouldering all the pain. If that's the case then strap yourself in for the coming wave of inflation. The real crisis will hit the UK if demand doesn't turn up sharply - in that case there will need to be startling budget cuts - cancellation of Trident, reductions of salaries in the public sector, real cuts in NHS spending and ever higher government borrowing costs

I've been agonizing over the recent rally in stocks. Being 60% in cash, 30% in bonds and 10% in stocks hurts.Why have I been so wrong? Could it be the rally in the FTSE over the last month is a recognition by institutions that governments have opted for inflation to get them out of this mess?. At this stage of the inflationary cycle beaten down stocks must represent a pretty good 3 year option .

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