We believe 2010 will be a critical year for investors. To simplify matters, there is a choice. Do we believe the fiscal stimulus experiment has worked and we are moving into a period of long term recovery with current asset prices at fair value or do we believe the fiscal stimulus has provided a short term answer and we have to face up to the fundamental economic issues which face us which will in turn revalue asset prices downwards.

Our analysis can best be summarised by the 3 d’s; deleveraging, deflation and demographics.

The growth of the economy and asset prices during the 90’ and 2000’s have been built on high levels of consumer spending funded by a huge expansion of private debt. The debt has been supported by rising asset prices. This is clearly demonstrated in the UK by rising house prices. As the value of homes have increased exponentially, home owners have felt comfortable with securing extra borrowing to fund personal expenditure. In his report, Steve Keen (Australian economist) provides figures showing private debt in the US at the end of 2008 was valued at $42trillion. Money supply was measured at $8trillion. These figures show the extent of the problem.

When asset prices can no longer rise and economic conditions worsen, consumers will not increase private debt and this reduces consumption. The next stage is to repay the debt (deleveraging) and this corresponds to the natural cycle of events. Its main effect is to bring down asset prices.

Reports from fund managers, economists and investment analysts, provide a wide range of opinion in regard to inflation. It appears sensible that if we are in a period of economic slowdown, inflation is likely to be moderate. If we add the global deleveraging of private debt that needs to take place, deflation is a real possibility………

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