The dangers of deflation

In long-term perspective there are two scenarios for the global economy: severe deflation and strong inflation, as they might come one after another in this order.
Severe deflation will mean further shrinking of consumption, unemployment in the double digits. More downside for commodities. Oil might take the elevator to the lower 30s. If this happens, we might see another 30-50% decline in the stock markets, as soon as next year. Earnings expectations are still elevated and negative earnings surprises in the coming quarter might shave the Dow with razor number 6. Many emerging countries will default on their credit following the example of Ecuador last Friday – a dangerous practice that usually leads to tightening of the credit markets, which hurdles economic growth. Severe economic crises around the world might lead to forced change of governments and a revival of nationalistic political systems. No country is insured against the unsatisfaction of the crowds. Countries which have enjoyed higher economic standards during the last decade should be particularly aware of sudden economic slump. People seem to be motivated more by the thought of losing something that by the thought of gaining something of equal value. James Davis states that we are most likely to find revolutions at a time when a period of improving economic and social conditions is followed by a short, sharp reversal in those conditions. Thus, it is not the traditionally most downtrodden people – those who have come to see their deprivation as part of the natural order of things – who are especially likely to revolt. Instead revolutionaries are more likely to be those, who have given at least some taste of a better life. When the economic and social improvements they have experienced and come to expect suddenly become less available, they desire them more than ever and often rise violently to secure them. For instance, it is little recognized that at the time of the American Revolution, the colonists had the highest standard of living and the lowest taxes in the Western World. According to historian Thomas Fleming, it wasn’t until British sought a cut of this widespread prosperity (by levying taxes) that the Americans revolted.
The other, and ironically the preferred path, is inflation. The US government desperately is trying to inflate the economy, trying to prevent Great Depression number two from happening. The financials injections in the economy will lead to severe weakening of the dollar. People, who keep their money under their mattresses or in low interest savings’ account will get poorer. The only way to offset the decline in the purchasing power of your dollars will be to be invested in the stock markets, which are supposed to rise during periods of inflation. Commodities will renew their upward spiral.

Analysing yourself

“At the end of each trading day (week) you shouldn’t focus solely on your P/L. Instead, focus on your thought process during the day and how well you executed your plan. If you consistently execute your trades according to plan and still lose money, then you need to reevaluate your approach. While there is definitely a cyclical rhythm to the market, no strategy will always work. You need to constantly¬† and objectively¬† review what is working and what is not so you can make necessary adjustments to you plan.”

Brian Shannon

Having a plan

Having a plan of action allows you to be objective when others are often reacting emotionaly. Every weekend I sit and create a list with potential trading candidates for next week. I choose 5 longs and 5 shorts, representing different industry groups, which my analysis reveals that might have a significant move during the week. Watching such a small number of stocks helps me to be more focused and objective. Usually only 2 or 3 out of the chosen 10 stocks will behave the way I expected, but in my scheme of things this is more than enough.