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Deflation Is Coming (and It's Not What You Think)

Update: This is an eerily prescient story from Shah. In the few months since we've published it, the wheels have come off the bull market (for the time being), and the danger of deflation looms larger and larger. Shah tells us what we need to do to come through unscathed. Here's Shah.

Be careful out there.

The stock market rally that started in March 2009… The one that's taken us out of the Great Recession and to new highs… The rally that's driving sentiment indicators of people who benefit from rising financial assets directly, peripherally, or because they hope all boats rise with the market…

The rally has never been loved.

The thing is, equity markets don't need love to go twice as high from here, or three times as high in the next 20 years. If they get what else they need, they'll keep going higher.

We could be on the verge of a generational bull market. That's if deficit-plagued, interconnected global sovereigns deleverage and, at the same time, re-capitalize middle and rising classes by making "recourse-sound" capital available and simultaneously reconstituting entirely the notion of taxation.

Too bad the likelihood of that happening is somewhere between slim and none.

That's one reason why I'm an increasingly reluctant bull.

But there's another reason too.

And it has to do with deflation…

The other reason I'm increasingly reluctant is because governments have been running their printing presses nonstop.

The Most Unloved Bull in History Is Unloved for a Good Reason

Your high school science teacher always told you, "Correlation does not imply causation!"

But, as you can see, there is an extremely high (95%) correlation between the expansion of the Fed's balance sheet, and the  S&P 500's gains over the past for years and more. This can't be a coincidence.

[Click to enlarge]

What will happen if they don't stop? What will happen if they do stop?

Besides printing on account of deflationary fears, printing money globally to keep up with the Federal Reserve's massive quantitative easing (QE) experiment has been necessary to offset the Fed's intended consequences to depress the U.S. dollar.

Everyone wants to export their way out of slow growth. The U.S. is no exception.

But printing money – in an articulated policy – to pump up asset prices that benefit from low interest rates, a depressed dollar that benefits exports, and positive overseas revenue translations has been fueling asset price inflation for five years. It's also been leading a beggar-thy-neighbor campaign. Neither of those are sustainable.

When stimulus slows – or if it stops being effective – we'll see whether there's sufficient global growth and fiat trust to avoid deflation.

That's what central banks worry about, a lot more than asset bubbles.

So, is deflation coming? Yes and no.

It's not coming in the way most people think about it… at least, not at first.

Here's What Keeps Me Up at Night

The deflation that's coming first is coming to financial assets.

That's what I worry about. I worry about asset bubble deflation.

I worry that we're now 10% above where stocks, as measured by the Dow Jones Industrials, were at their 2007 peak. That just means we've made back all those credit crisis and Great Recession losses – theoretically – and may have started a new bull market.

And a 10% up-leg doesn't impress me when it's built on leveraging a zero interest rate policy.

So we just had a better than expected jobs report where 204,000 people landed jobs instead of the 120,000 analysts expected? So what if the previous two months saw slight upward revisions?

The unemployment rate still went up, not down.

The labor participation rate fell by 0.04% (to 62.8%) in October. That's the lowest rate since March 1978. It means fewer people are looking for work. More people are disaffected.

Speaking of analysts' revisions, so what if 70% of half the companies in the S&P who've reported earnings for the third quarter beat analysts' expectations? They all lowered them after last quarter to make them easier to beat. And they're lowering them again now because CEOs are guiding future expectations down again.

These days, revenues are rising a lot more slowly than earnings – if they're rising at all.

This begs the question: If the rate of change of revenue growth slows and earnings growth from buybacks (which by some measures could have added 40% to rising prices), productivity gains, and cheap debt financing slows down, aren't stocks fully priced? What's left for them to feed on?

So what that consumer sentiment is rising with stock prices? It's been rising because of rising home prices, too. How many stocks and how many homes do most people own? Oh, that would be a lot fewer than before the housing bubble broke and stocks crashed.

So what if volatility is at historic lows and seemingly resting comfortably there? That goes hand in hand with margin debt being at record levels.

This Party Won't Last Forever

It's all just one big party – as long as there's punch in the bowl and revenue to feed profits.

And that's where we are. We're at the intersection where asset price inflation (driven by stimulus) meets the real economy's ability to produce goods and services to sell to people who can afford them, as opposed to being redistributed to them.

Tapering, when it comes, will be scary.

Not that it's coming soon. But it is coming.

That's good news. Because there's going to be plenty of time, maybe a few more quarters if we're lucky, to get sufficiently defensive and put on strategic short positions. Do that now, just in case global growth isn't there to augment the soon-to-be-diminishing returns of quackitative easing.

The market has upward momentum. We're going into the holiday season where spending picks up. There's a better than even chance if the market moves higher a lot of institutional managers will buy up the winners to window-dress their fourth-quarter and full-year returns.

It's unlikely that Helicopter Ben will slow down QE right before he leaves office next year. He'll let his successor make her own policy decisions. Why would Ben risk wrecking the rally that he engineered when he's on his way out the door?

Over in my patch, we're adding selectively to positions that pay nice dividends, and we'll be happy to add more to those positions if the market falters. We're playing in the hot technology patch, and we're starting to put on some defensive positions in the Capital Wave Forecast portfolio too.

You don't have to love this market, but you do have to be in it. And you have to understand that, love it or hate it, the market can't go up in a straight line forever.

Join the conversation. Click here to jump to comments…

About the Author

Shah Gilani is the Event Trading Specialist for Money Map Press. He provides specific trading recommendations in Capital Wave Forecast, where he predicts gigantic "waves" of money forming and shows you how to play them for the biggest gains. In Zenith Trading Circle Shah reveals the worst companies in the markets - right from his coveted Bankruptcy Almanac - and how readers can trade them over and over again for huge gains. He also writes our most talked-about publication, Wall Street Insights & Indictments, where he reveals how Wall Street's high-stakes game is really played.

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  1. Matteo | November 14, 2013

    Hi Shah, very nice article.
    What do you think, from your point of view, the future for Silver in the next 3 months?

    thank you!

    • Fernando | November 14, 2013

      Silver is in trouble right now.

      • ElectroPig Von Fökkengrüüven | November 15, 2013

        I think that silver isn't "in trouble", but suffering from obvious price manipulation.

        I may be wrong, but what I've learned over the last few years leads me to consider the possibility that larger investors and mining companies are maintaining downward pressure on silver and gold to flush out the competition, kill off the smaller players, and snap up their assets for pennies on the dollar.

        If that idea is correct, once the smaller players–the ones who were doing very well a couple years ago, due to their previously-lower overhead vs output–are run out of business (in true corporate monopolization style) and snapped up by the larger operations, things might get a little bit closer to normal again.

        Of course, there is the institutional manipulation that also has to end before prices stabilize, or return to their natural "in the ground" price ratios, and there will likely also have to be a decoupling of "paper silver" with "physical silver", and the same with gold, before the games are truly over with.

        When it's all said and done, the multi-level, multi-point manipulation is now known to almost everyone, so they can't keep it up much longer. When one leg of a tripod breaks, it all comes tumbling down…and that's when silver and gold should rise again.

    • Owen K. | November 14, 2013

      Silver and gold spot prices are being affected by central bank manipulation. See GATA (Gold Antitrust Action Committee) website for details on gold and silver spot manipulation.

    • jamie perry | January 13, 2015

      So what do we do with our uninvested cash?

      • Very well written (and intelligent) article. | May 22, 2015

        5/22/15 What is your long and short term opinion of ticker symbol ARLP (Alliance Rescource Partners LLC) Thank you very much for your consideration.

        Ian Laughlin

    • Very wekk written (and intelligent) article. | May 22, 2015

      5/22/15 Ticker symbol ARLP (Alliance Rescource Partners LLC) is most likely not a stock you follow, but then again, maybe it is. I have owned it several years and it is in the riskier part of my portfolio (by intent), and has consistently paid a very good, and dependable, dividend (at least so far) and I have read that even though it is in the coal industry, it does have some geographical, and other factors in it's favor which give it a competitive advantage. I would be very interested in reading what your short and long term opinion is of it Thank you very much for your consideration.

      Ian Laughlin

  2. H. Craig Bradley | November 14, 2013


    There is much inconclusiveness in life. We see and hear about it every day in different forms and on different issues. For example, a ongoing debate about ObamaCare is ensuing and commentators are feigning indecisiveness about " Did Obama Lie about Health Care when he made his promises". Another favorite is: "Do we have any bubbles out there? ( stock or real estate).

    Another ongoing debate is do we have inflation or deflation? The answer seems to be both based on observation and reading. So up to now we do not have "deflation", but instead only "disinflation". The fact of the matter is the money supply (M2) has gone up while M2 Velocity is at a decades low of 1.55. Apparently our "new normal" consists of a combination of former understandings in a way that proves everybody wrong and at the same time right.

    We have confusion and the more cautious types are not about to jump on the bandwagon because obviously, such disagreements are yet another manifestation of greater uncertainty (risk) and to a certain degree, a lack of confidence in the future. The stock markets still indicate the future, don't they?

    • Robert in Canada | November 15, 2013

      The fact that a lot of people are still invested in bonds or just cash could mean there is room for stocks to go up.

      Since M2 velocity is most likely to go up rather than down in the future, wouldn't unleashing all that cash cause stocks to go up?

  3. Jim | November 14, 2013

    What do you mean in saying "The deflation that's coming first is coming to financial assets." Which financial assets and what will happen to them ?

  4. Walter Baltzley | November 14, 2013

    "We're at the intersection where asset price inflation (driven by stimulus) meets the real economy's ability to produce goods and services to sell to people who can afford them, as opposed to being redistributed to them." –Thanks to advances in technology, the "REAL" economy is able to produce more goods and services than ever before. Computers, Robotics, 3D Printers, and Nanotechnology increase our capacity by several orders of magnitude.

    Unfortunately, people cannot afford this abundance because the same technology has put them out of a job.

    I agree with your solution, "…re-capitalize middle and rising classes by making 'recourse-sound' capital available and simultaneously reconstituting entirely the notion of taxation." And I propose implementing it as Universal Income Credit.

    The Government needs to issue interest free CREDIT to The People in good faith that they will create value and grow the economy. This credit needs to be (1) Paid for using NEW Money, (2) Given to each citizen equally, regardless of income, on top of their earnings, (3) Be enough to live on ($20-30,000 usd annually), (4) Require a minimum social contribution of 20 hours/week in the form of employment, volunteerism, or education.

    The government should continue to issue this CREDIT, until the economy is at full employment and growth begins to slow.

  5. Dirk | November 14, 2013

    As long as you do not revive the New York garment district and buy your own gravestones in China instead of manufacturing them in some small twon in your Middle West (THE ECONOMIST a few years ago) and do not assemble some of your electronic gadgets which you discard anyway after 12 months max. as something more exciting come up, well as long as you as a nation are fixated to enrich yourself trading paper (the Alan Greenspan of the pre-October "big bang" – yes here not the bang of "freeing" of financial markets by the abrogation of Glass Steagall, but their implosion: "America does not need a manufacturing sector"), then you will have a problem with your "underclass" who need simple assembly jobs. At the end the end of the day it will be the end of team USA.
    This is not being against free markets and competition and and being an advocate of sky-high customs walls. It is aso not a problem of imports of foreign cars (most of them build them by now in the US or in Mexico). It is simply this disregard and disrespect for the little guy and the mother with ony a highschool diploma (or even without it) who needs and wants a decent job to do with her hands, because its all she has got after going thru your great American elementary school system. Just read again your and our Friedrich List, the middle of 19th century economist of free markets, but with some sense and mutual respect of industries in weaker countries.
    God bless America – Dirk

  6. James | November 20, 2013

    Agree with you.

    We are in an unusual long term bull market. Slow economic growth has been a bonanza for stock investors. The economy is rising very slowly; unemployment remains high although declining; and employment is increasing gradually.

    Even our dysfunctional Congressional leaders have helped by tempering our economy from overheating. Reducing our deficit has meant cutting back on federal employment and employment in government related industries. The private sector is spurring the growth in employment; not the government sector. This is an amazing feat!

    U. S. Attorney General Eric Holder is finally doing a gang buster job going after the big banks like J P Morgan Chase for their transgressions leading to the Great Recession. In other words, big banks are not getting away from their wrongdoings. Justice will be served. Next in line are Bank of America, Wells Fargo and Morgan Stanley, according to CNBC. Finally, finally the U.S. government is going after the big bad Wall Street institutions. If anything, cleansing Wall Street may be the biggest achievement of President Barrack Obama's term of office and not Obama Care. Delegating the job to AG Eric Holder may be his best decision while in office.

    Yankee ingenuity is sparking our economy with the introduction of new technology and applications. The U.S. is leading the way in digital revolution. It is transforming our country and the world. Shale oil is another revolution and transforming our country from a net importer to a net exporter of oil. Wow! … so many earthshaking events occurring, and all originating in the U.S.A.

    The U.S. is still the greatest country in the world because it is an open forum for freedom of speech and expression. Sooner or later, through all the confusion of ideas and disagreements, the U.S. comes out smelling like a rose to do what is right.

    I am full of optimism.

    The party will end …. some day in the future. That is reality. Business cycles are facts of life. The economy goes up and it goes down. So too, the stock market.

    In the meantime, like you said, "You don't have to love this market, but you have to be in it." Of course. We are in a bull market and it has a ways to go.

    (Hey Shah, in your Money Market Report, you recommended Vodafone. I took your advice and am very comfortable with that investment. Could you please make another follow-up article. You already wrote two articles on Vodafone. Verizon Wireless is planning to purchase Vodafone's 45% interest in the company and rumors are flying that AT&T is planning to buy out Vodafone later next year. What are the implications? Should we investors buy more shares of VOD?)

  7. Joseph Lapinski | February 14, 2014

    It's unlikely that Helicopter Ben will slow down QE right before he leaves office next year. He'll let his successor make her own policy decisions. Why would Ben risk wrecking the rally that he engineered when he's on his way out the door?
    we are 2/14/2014 and you're acting like you are talking in the present but you're 1 1/2 months behind.

  8. John | November 30, 2014

    Excellent article and pretty much spot on. It's now 1 December 2014. A year after this article was written and I'm afraid the chickens have come home to roost. Oil has dropped below $70 a barrel. A massive deflationary spiral has commenced which will likely result in financial Collapse in Japan and Europe but ultimately the world. The 19th century Economics of infinite growth with finite resources simply cannot work. Any thinking person knew this but we effectively the created the Doomsday machine in corporate capitalism. It has no off switch. Greed, profit, consume everything. It certainly does not tolerate anyone trying to stop it. The resource crisis (too many people, not enough dwindling finite resources) would always manifest itself in economic collapse first. Like the Romans before us our civilisation is teetering on the brink of extinction. The only difference being that no one will be around to write about this one in the History books.

  9. Richard Brice | March 24, 2015

    I am an Expert on The USA Finance's.

    What Planet is this Shaw Galani from.

    The United States of America has the Best Economy over all the Country's in the World.

    Forbes, in 2014, Published the twenty five most Powerful People in the World,

    Putin of Russia was shown as the Number One most Powerful, because of his Invasion of the Ukrain.

    USA President Obama was shown as the Number Two most Powerful, because the United States has the Best Economy in the World. North Dakota has an unemployment of 2.1% , Nebraska 3.2 % , Wyoming 4.2 % , Colorado 4.3 % .

    There are some States with an unemployment of over 6 %, which is an indication these States do not have an Auditor monitoring there Finances. The United States knows how to Correct the unemployment.

    The USA Dollar is the Highest Currency in the World, which may require it to be devalued, so Mfg. Products will not be too Expensive.

    All Country's in Europe have a very High Unemployment Rate, some as High as 25%, and NO knowledge on how to Correct it.

    • Jeff Moebus | May 1, 2015

      Richard you are a true expert,
      Tell me who owns the Federal Reserve Bank ?
      and who controls it?

  10. Leonard Bellam | June 16, 2015

    Hello Mr. Shah Gilani

    I was correct with the direction forecast that I have given to a gorgeous girl/woman in April of 2015 which was the bear market which is coming our way for next year. Was I correct assuming that you agree with my predictions Mr. Shah Gilani is the question that I have because I determined a bear market to be nearly the same. As a deflationary period and a recessionary period are the same result where both produce negative growth in the economy. Even though, deflation is a general decrease in the price of goods and services in the economy and a recession is negative growth in the economy they are eerily similar because neither in my books are good for the growth prospects of the economy affected. The analysis that you have given adds to the conviction that I have had of the question of what comes next for the US economy after what I had assumed was a market bubble for the past 3 years that I have been watching the world markets. I enjoyed reading what you had to say in this report because it has given me the confirmation that I have needed to my held speculations which I have held for over the better part of a year, and it has given me a guiding light to what I assume will be my own prediction of the course of the US economy over the coming decade. thank you so very, very much for your report, please have a great day, and I do send the best wishes to your loved ones and yourself.


  11. Don Mucheck | August 15, 2015

    I feel your article has more values now I 2015 then when it was written in 2013. The Germans economy trying o ease Greeks an maybe France and Germans easing Portugal troubles. When does England attempts to eases European's market? While at the same time US is trying to raise the minimum wage to $15.00 when production demands is not at that level or those business to support such a raise in labor. My question is what stocks or market should one begins to invest in order to protect against deflation and perhaps another global recession. I feel that most stocks are presently over valued. would mining, food production b great hedges if such event occurs

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