The first point I want to address is Tepper’s bullish stance on stocks. Being bullish on stocks has turned into a contrarian play. I like this. Being bullish on stocks while being bearish on the economy (like myself) is the ultimate contrarian play. I like this even more. In this interview, Tepper touched upon one of the reasons I often note about why stocks will rise in a weak economic environment- namely, the Fed. Deflation is a choice in a pure fiat system. Remember that. When the Fed opens up the spigots in response to a weak economy, asset prices will rise.
The second point I want to address is about deflation. Now let’s think for a second about what makes deflation devastating. After all, at first glance, lower prices should be a good thing. Well deflation is destructive because it makes the real value of debt increase. In the context of an over-leveraged U.S. economy, deflation is obviously a real concern.
The biggest debt obligation most people have is their home mortgage. Most deflationists point to the decline in home prices and go on their little spiel about debt default Armageddon in America. But the mistake deflationists make is focusing simply on the decline in home prices while ignoring mortgage costs as a percent of disposable income. While home prices have fallen off considerably, so have mortgage costs. Granted many people have not been able to refinance at record low rates, but these are low-equity borrowers with less than stellar credit. Let’s be honest, these people would be in trouble in nearly all economic environments.
Now don’t misunderstand me, I’m not bullish on housing at all. What I’m trying to say is that the average person is going to be OK coming out of this because they will look out for themselves. This means they will simply stop paying their mortgage, default, and become renters. Losses then get transferred to banks. It is the contraction in long-term credit stemming from these bank losses that is going to keep home prices depressed for a long, long time. The people who are really going to get screwed are those who have accumulated equity in their home. These people will watch in horror as their “savings” vanish at the same time expenses increase. Inflation is coming, but home prices will not rise in line with inflation. Leverage is the name of the game in housing, and leverage has disappeared.
The conflation of deflation and economic Depression is one of the biggest mistakes people make. We are in a form of a Depression that will eventually bring substantially higher inflation. The swings in various asset classes are going to be very confusing, so it will be prudent to discard standard wisdom and view markets objectively.The only way for us to get out of this crisis has already been hinted at by the Fed- inflation. Investment decisions moving forward should revolve around this high probability event.