BMO CM Basic Points Sept 2009

Basic Points
Dem Blues
September 3, 2009
Published by Coxe Advisors LLC
Distributed by BMO Capital Markets

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Don Coxe
THE COXE STRATEGY JOURNAL
Dem Blues
September 3, 2009
published by
Coxe Advisors LLC
Chicago, IL
Dem Blues
September 3, 2009
Author: Don Coxe 312-461-5365

DC@CoxeAdvisors.com
Editor: Angela Trudeau 604-929-8791

AT@CoxeAdvisors.com
Coxe Advisors LLC. www.CoxeAdvisors.com

190 South LaSalle Street, 4th Floor
Chicago, Illinois USA 60603
Dem Blues
OVERVIEW
The stock market’s September Song is traditionally the blues. If this year’s
music of the markets follows the customary dance card, it will be a sharp
mood swing from the splendid revels and boleros of spring and summer.
Why should the blues be back? With the S&P up by a half since March, then
the recession must be yesterday’s story, and the next bull market has begun.
That’s what most of the major indicators—ISM, Leading Economic Indicators

and their like—tell us.
Using Fed Chairman McChesney Martin’s hoary punch bowl analogy, the
trebling of the Fed’s balance sheet and sustained near-zero interest rates have
done their work: the equities party this time isn’t just “interesting”—as it was
in previous cycles—but nearly Rabelaisian.
Except that it’s not just stocks that are rising: so are foreclosures,
unemployment, bankruptcies, bank failures, and government deficits at all
levels. The story of our time has become a Tale of Two Ditties: Roll Out the
Barrel, and Brother, Can You Spare a Dime?
This month, we update major cautionary themes we have been discussing in

recent issues, in the light of months of ebullient stock markets, an increasingly
bullish economic consensus, and a potentially historic shift in voters’ views
of the financial and economic implications of President Obama’s policies.
Each week, we read analyses from strategists and economists comparing

this recession to its predecessors all the way back to the Depression, on
the implicit assumption that we remain in an historic continuum. Yes, each
downturn has some different characteristics than others, but the unstated
axiom in the reasoning is that the US and other OECD economies today can
be understood best by understanding how they have behaved at past turning
points.
In our view, this recession is unlike any other since the onset of the Industrial
Revolution in two crucial respects:
• it is the first to hit North America and Europe in which deteriorating

demography is a key ingredient—and none of the policymakers and almost
none of the elite economic forecasters even mention it;
• it is the first in which the continued strength of the economies of China, and,
to a lesser extent, India and East Asia, is widely recognized as the condition
precedent to a global recovery, yet the consensus remains unwilling to draw
the obvious conclusions from this historic transformation.
September 1
We believe that these unprecedented factors make forecasting the shape and
strength of the US and European recoveries unusually difficult. Policymakers
within the OECD nations are resorting to programs and remedies with roots
in Keynesian and Friedmanesque formulas that either should have been
used to prevent or end the Great Depression, or that have been employed in
subsequent recessions with apparently successful results.
But what if the world is changing so decisively that massive deficits and
Depression-era interest rates will not produce—on a sustainable basis—the
anticipated good results for the US and other major OECD economies whose
demographic decay is even more serious than America’s?
This month’s title is a riff on America’s unique music form. We use it to

discuss (1) the implications of the continuing US demographic decay and
(2) a possibly momentous shift in American confidence in the Democrats’
ambitious programs to reshape the economy after it escapes the recession.
President Obama’s approval ratings have fallen precipitously since our last
issue, as have the ratings for the Democratic Congress. If, with the post-
election glow gone, the recovery were to falter, it would be very difficult
for the President and his party to rally public support for new stimulus
or bailout legislation, and investors worldwide might begin to factor a
failed Presidency into their appraisal of US financial assets. The image of
a handsome, smart, creative, popular President who would blow away the
Bush Blues was wondrous for Americans’ view of themselves and the world’s
view of America. If that image were to crack in Dorian Gray fashion, it could
be a real negative for US equities and America’s ability to finance its coming
decade of deficits.
We believe most equity groups in the US are due for a correction that could
be quite prolonged, but we remain bullish on Emerging Markets as an asset
class, and on commodities and commodity stocks.
Given that outlook, we think balanced portfolios should reduce endogenous

risk. We are adjusting our Asset Mix to increase bond exposure—both in
percentage and duration terms—and are reducing recommended levels of
US and European Equities, and Cash.
2 September THE COXE STRATEGY JOURNAL

Dem Blues
The world’s power balance is changing dramatically. If it continues to unfold as
some leading forecasters predict, it would be one of a mere handful of gigantic power
shifts that have shaped the history of the West. The world’s power
balance is changing
Here is a capsule summary of the tectonic shifts that reshaped the West:
dramatically.
1. Rome managed to unite the societies of the Italian Peninsula, and thereafter
conquer most of the then-known world in an empire whose economic
activity flourished for six centuries under the protection of Pax Romana.
Rome’s legions achieved dominance over the major food-producing
regions of the Mediterranean; the Silk Road became the linkage between
Europe and Central and Eastern Asian civilizations, and those connections
would define trading relationships for most of the centuries, until Europe
discovered the sea route to Asia at the end of the 15th Century. The Roman
Empire began to decline when...
Its internal contradictions and the costs of imperial overstretch led to the
decay of Augustan values. Farmers abroad began to find ways to avoid
sending their output to Rome. Piracy flourished anew in the Mediterranean.
Inflation became endemic, and successive emperors resorted to currency
debasement so the Roman denarius was no longer automatically accepted
by traders abroad. The barbarians were able to sack Rome in 410 A.D.
mostly because Romans had long since lost faith in their system.
The Goths and Vandals were mere looters, not empire-builders, so, during
the Dark Ages after Rome’s fall, that power vacuum at the top was filled
by a new military and economic power.
2. Islam’s astonishingly swift advance into Western Europe was finally halted
by Charles Martel at Poitier in 732. But the Caliphates would remain
an enduring challenge to their neighbors for another thousand years.
It took until 1492 for Spain to dislodge the last remaining bastions of
Muslim power in Western Europe. Constantinople and Trebizond fell to
the Turks, and the Ottoman regime in Istanbul continued to control the
Eastern Mediterranean until the new Rome—in the form of the Catholic
Church—was able to assemble “The Holy Fleet” of Catholic states and
crush the Turkish fleet in the Battle of Lepanto in 1571, (ranked as one of
history’s decisive sea battles). Thanks to Arabic advances in mathematics,
September 3
Dem Blues
and control of the Silk Road, the Islamic world, despite its internal
rivalries, was the most prominent economic force in the Mediterranean
and Southern Europe, until the discoveries of the New World and the
sea route to Asia. After losing control of Greece in 1821, Ottoman power
Napoleon’s rise and declined, and by the late 19th Century Turkey was so weakened that it was
fall had the dismissed as “The Sick Man of Europe.”
unexpected effect of
Europe was not able to offer a new candidate for international leadership
paving the way for the
during the centuries of Turkish power until it produced a nation with the
first truly global
requisite combination of military and economic pre-eminence. That took
empire—Britain.
centuries.
Nation states only began emerging in Europe during the late Renaissance.
Prior thereto, the growth of commerce proceeded from regional trade
systems, such as the Hanseatic League, and the networks of Italian city-
state banking and trading houses. No nation was able to project its power
militarily on a sustained basis, thereby giving it control over trade patterns.
The Hapsburg Dynasties and the Holy Roman Empire lacked cohesion,
popular support, and integrated economic strategies. They were, however,
noteworthy patrons of art and music. (Think Haydn, Beethoven and
Mozart.)
3. Napoleon’s rise and fall had the unexpected effect of paving the way for
the first truly global empire—Britain. For the first time in Europe’s history,
a nation was able to prevent conquest by superior armies and ultimately
destroy its attacker because of its navy, backed by its wealth and technology as
the pre-eminent industrial economy. Despite the loss of its 13 colonies, Britain
retained possession of a globe-girdling empire—“a domain created, [in
De Valera’s words] in a moment of world absent-mindedness.” The British
Navy’s prowess meant that Britain was able to maintain its far-flung empire,
control piracy, source many of the materials needed by its industrialists,
and maintain a free trade policy until…
4. Germany emerged as the industrial and military challenger to Britain.

The German states were still only loosely united in 1866 when Prussia,
under Bismarck’s leadership, conquered Austria. Five years later, Prussia
overwhelmed France in less than nine weeks after the French leaders, in
a display of utter folly, declared war in 1870.

Bismarck took advantage of that victory to achieve German unification. His
shrewd strategizing managed to contain Papal influence and overcome the
historic enmity between the Catholic and Protestant states. The German
Empire emerged as a global power able to challenge Britain. Bismarck had
his own policy for German greatness: autarky. The new Germany had to Bismarck had
become as self-sufficient as possible, so it could, if necessary, withstand a his own policy for
blockade by France on land and Britain at sea. In search of raw materials, German greatness:
it acquired African and Southeast-Asian island colonies, and it began to autarky.
build a technologically-advanced navy that could challenge Britain’s rule
of the waves. Backed by bourgeoning accomplishments from German
scientists, an industrial colossus was born.
It was inevitable that Germany would eventually challenge Britain for

world leadership. Both nations believed there was room for only one at
the top.
When the Clash of the Titans finally came, both sides lost heavily, as
the industrial and financial might of Britain and Germany bled into the
trenches of World War I. Into this vacuum flowed the USA, the world’s
newest—and largest—industrial power.
5. America’s pre-eminence has continued to this day. In the Reagan era, it was
able to best its only challenger—the USSR—without a major war through
policies which would have evoked admiration from Bismarck: building
and maintaining a superior military, (including the world’s strongest
navy), and a superior industrial and technology-based economy that was
also largely self-sufficient in food.
During the lifetime of our readers, the USA has been the foremost power—
economically and militarily.
Who’s next at the top?
Basic Points has frequently cited the prophecy of Oxford Chancellor Chris
Patten, that the US will yield its economic leadership to both China and
India in the first half of this century.
This recession has put that process on fast-forward.
History suggests that America’s unchallenged military pre-eminence will

fade along with its economic ranking. Already, as Niall Ferguson observes,
China’s fast-growing navy challenges traditional American hegemony in the
Pacific.
September 5
Dem Blues
The Turning of the Page

The night-and-day contrast between the performance of the US and Chinese
economies is finally beginning to attract the attention it deserves. On August
24th, The New York Times briefly averted its gaze from the search for green
It’s Asia that’s lifting
shoots, and took a lengthy look across the Pacific. It quoted Neal Soss, chief
the world...
economist for Credit Suisse in New York: “The economic center of gravity
has been shifting for some time, but this recession marks a turning point. It’s
Asia that’s lifting the world, rather than the US, and that’s never happened
before.”
The report continued, “The United States is also being shoved aside as the
make-or-break customer for export-driven nations like Germany and Japan.
China overtook the United States as Japan’s leading trading partner in the
first half of 2009, while in Europe manufacturers are looking east instead
of west…Deutsche Bank released a report titled ‘Eurozone Q2 GDP: Made
in China?’ French exports to China and other East Asian economies rose
18.7% in the second quarter…a sharp turnaround from the 16.2% drop in
the previous quarter.”
It concludes with a quote from Simon Johnson, formerly of the IMF: “It
reflects how the world is changing, and economic power does translate, of
course, into political power.”
Indeed.
President Hu Jintao lacks President Obama’s eloquence, but his progress in

asserting China’s influence abroad means that nations across the world are
looking at the numbers—including Obama’s plunging polls—and drawing
their own conclusions about which nation they wish to take more seriously.
The 19th Century French leaders watched enviously as the world began
listening to Disraeli, Gladstone and Palmerston—and then Bismarck.
Until recently, there were few forecasters who believed that the US would
have to yield its hegemon status to China within a foreseeable time frame—if
ever.

Naturally, most forecasters deride this prediction. They note that there have
always been naysayers who announced the coming end of the American
era. One reason John Kennedy managed to win the Presidency was because
so many Americans had accepted the view that was then so popular in
intellectual circles that the vigor and vitality of Communism would make Carter busied
the USSR the world’s #1 economic and military power within a few years. himself in turning
Sputnik sparked something approaching panic among many Americans. out the White House
How could a country so recently devastated by war not only get the Hydrogen lights, and musing
Bomb, but also be the first into space? When Khrushchev banged his shoe about malaise.
at the UN and shouted, “We will bury you!” he had many US believers—
notably in prestigious universities. Ho Chi Minh won his war mostly because
a majority of Americans no longer believed the war was winnable, and a
large percentage of American elites believed the US had entered decline.
Nixon’s disgrace, the Ford interregnum, commodity shocks, and stagflation

combined to elect Jimmy Carter, who encapsulated the new consensus that
American pretensions of pre-eminence were dangerously outdated in the new
bipolar world. Even his trademark garb bespoke the national chastening: the
cardigan was the sweater named for one of the British commanders who
ordered the Charge of the Light Brigade. Carter busied himself in turning out
the White House lights, and musing about malaise. His decision to withdraw
all support from the Shah in favor of the Ayatollah Khomeini triggered the
second oil shock, an inflationary recession, and the humiliation of the
444-day imprisonment of US embassy personnel in Tehran.
At that point, the USSR looked like the only major nation with the right
combination of military excellence and the strategic determination to gain
and maintain power globally that were the requisites of global leadership.
Fortunately, a President the elites ridiculed as a B-Movie actor managed to

send Carter into retirement—and send the US to new heights of global power
in both military and economic terms.
So we should, perhaps, be cautious about assuming the US is on its way to

second-rate status.
However, it must get out of this recession and get back on the path to
prosperity.
When will that happen?
September 7
Dem Blues
Thinking About Tomorrow

Six months ago, the regnant economic forecast held that the US would be the
first of the major Western economies to emerge from recession.
It was as if When the recovery came, America would rejoin the global growth club, which
Santa Claus had was down to just two members—China and India. Neither came even close
suddenly been found to falling into recession.
and funded, and
The shared wisdom that America would lead the OECD back to prosperity
was now delivering
was based, in part, on the appraisal of Washington’s rush to rescue American
on bagfuls of
banks and stimulate the economy. The multi-trillion-dollar rescues of the
“Dear Santa” letters
Bernanke-Obama team, based on Keynesian and Friedmanesque models
dating back to the
would, experts agreed, yank the US from its deep financial-driven recession,
Walter Mondale era.
while Europe would remain sluggish—at best. That optimism asserted itself
coming out of the March stock market lows, with the S&P soaring by 50%.
However, although most economists believe the US has already emerged

from recession, and total corporate profits, driven by ruthless cost-cutting,
are soaring, new doubts are emerging about the sustainability of this force-fed
recovery:
• jobless claims, which had been declining week-by-week, suddenly upticked

modestly in mid-August;
• bank lending for economic activity isn’t growing;
• foreclosures keep increasing;
• the stimulus of extremely cheap gasoline is fading with the doubling of

oil prices;
• state and municipal governments are collectively in crisis, led by California,

whose economy is larger than Canada’s;
• the Pelosi-Obama stimulus program turned out to be a perfumed

gallimaufry of old programs that had been silting up in party circles and
pressure groups for decades. It was as if Santa Claus had suddenly been
found and funded, and was now delivering on bagfuls of “Dear Santa”
letters dating back to the Walter Mondale era. Of the $900 billion allotted
by Congress in a crisis atmosphere, only $1 billion had been spent by June
on those widely-advertised “temporary and targeted” programs that would
put people to work building roads and bridges. (We are told that another
$9 billion should be spent by year-end.)

That is the Democratic Congress’s contribution to a quick, sustained recovery:
doing things the old Washington way—earmarks and all—but doing them
with a virtually unlimited budget.
Enter Dem Blues.

...the White House
As deficits—current and projected for the next decade—soared to previously was looking to a
unimagined levels, voters began to reconsider their enthusiasm for Obama. tomorrow—whose
Was “Yes, We Can!” not the great unifying force that would end the nation’s economy would not
polarized politics, but the sales pitch for enacting the old, moldering, gaseous be a Carbon Copy of
liberal agenda in the name of “Change You Can Believe In”? the present.
The Clintons’ theme song was Don’t Stop Thinking About Tomorrow. For the
new hip-retro era, the theme song could be Everything Old is New Again,
which includes:
Don’t throw the past away

You might need it some rainy day
Dreams can come true again
When everything old is new again
Just right for the Administration that believes it would be a shame to waste
a good crisis, and uses that series of rainy days to bring back the past’s pet
schemes.
As for the Clintons’ theme song, this Administration hardly wants to get
voters “thinking about tomorrow,” when the taxpayers will be beset with
endlessly rising demands to finance those trillions and trillions in annual
increases in the national debt. As recently as 2006, the Democrats were
blaming Bush for maiming the economy with deficits “that could never be
repaid.” The Clinton era, in this roseate recollection, was a pre-Lapsarian
Eden that Democrats could regain. No more deficits: deficits were evil.
Now, we were told, as deficits soar to levels that make Bush’s look like the
unreformed Scrooge, they are “investments.”
In actuality, while the spending orgy on yesterday’s priorities was convulsing

Congress, the White House was looking to a tomorrow—whose economy
would not be a Carbon Copy of the present. Its Green sunlit uplands, warmed
the right way by sunshine, not CO2, would be populated with millions of
happy people performing Green jobs in wind, solar and renewable power,
such as ethanol, and technologies as yet undreamt-of, but which would
be born almost magically in American laboratories in response to vast
“investment” by Washington.
September 9
Dem Blues
Those uplands gambolers of the future would be protected by a health plan

that would cover everyone and cost less—without putting any caps on trial
lawyers, the #1 Democratic Party financing lobby. (The biggest single cost
difference between Canadian and US health care systems is the contingent-fee
Although trillions system for American trial lawyers which isn’t allowed in Canada—or, for
are hard to explain, that matter, anywhere else in the common-law world. Only in America are
voters understand lawyers’ fees and expenses payable by their clients, regardless of the outcome
that when billions at trial. That difference means that corporate defendants routinely choose to
are no longer worth settle without a trial, a practice that encourages costly, vexatious litigation. )
talking about, maybe
When we last published (June 8th), the Obama global warming and health
things are moving
programs looked to be on their way to the Oval Office for signature, backed
too fast.
by the President’s extraordinary popularity and persuasion skills. At that
point, he was still the most-admired President since Roosevelt.
What a difference three months make.
The “Cap and Trade” bill (aka “Cap and Tax”) made it through the House of
Pelosi, but it is in trouble in the Senate.
The real sickness is in health care reform. Despite almost-daily Obama

speeches and/or press conferences, public support for a major new plan
has withered. Although he blames the Republicans, his own party is deeply
divided. The Democrats have seemingly overwhelming majorities in both
House of Congress, and should, one might have thought, been able to whoop
through a new health program with little more delay than was accorded those
other trillions in expenditures. However, Speaker Pelosi says no bill that does
not contain a government health plan could pass the House, and Senator
Dorgan says no bill that does contain a government health plan could pass
the Senate.
The shock to Obama and the Congressional Democrats came in August,

at Town Meetings on Health Care across the land. Frightened, angry voters
grabbed the headlines. Sitting Democrats were stunned by the fear and fury
they encountered—not just from Republicans, but from their own supporters.
When the Congressional Budget Office announced that the Obama program
would achieve no meaningful cost savings, but would be part of an upwardly
revised $9 trillion deficit over the next decade, public support withered.
Although trillions are hard to explain, voters understand that when billions
are no longer worth talking about, maybe things are moving too fast.

According to last week’s Gallup, even the 50% of voters (down from a post-
election high of 70%) who say they still approve of Obama are upset by
the soaring deficits and their sense that he’s trying to do too much. They
question his ability to reform education with vast expenditures spent on
unionized schools, create a new health care system that will insure everyone It is rather sad to
but cost less, avert global warming, revive the US auto industry, reform Wall watch his magic
Street and kick-start the US economy into sustained growth. fading like the
Cheshire Cat’s smile...
Obama has kept much of his non-liberal support by sticking with his
determination to win the Afghan war with a new strategy and new leadership.
He recently addressed the Veterans of Foreign Wars, promising victory in
this “Good War.” But—and for that no fair-minded person should blame
him—the Taliban has apparently regained the advantage across much of
Afghanistan, and is also proving hard to dislodge from Pakistan. Obama’s
determination on Afghanistan is eroding his support among the hard left
wing of his own party.
It is rather sad to watch his magic fading like the Cheshire Cat’s smile, because
the deeply-indebted United States cannot afford a failed Presidency.
It would certainly help if he would stop blaming Bush for all the economy’s
ills and admitted that his primary problem is the one that apparently cannot
speak its name: the birth dearth.
The Birth Control on Economic Growth

At the core of the financial collapse was the multi-decade collapse in birth
rates—in America and across the industrial world.
This is the first recession in which the inadequate supply of new first-time jobholders
with the financial qualifications to become first-time home-owners was a proximate
cause of the downturn.
Backed by powerful Congressional Democrats through Fannie Mae and

Freddie Mac, by the Greenspan Put, and Wall Street’s kamikaze resort to
Long-Term Capital-style financial engineering, the criteria for mortgage
lending were successively debased and debauched. Trillions in loans based
on the conviction that house prices could only rise were granted to people
who would never have qualified in earlier cycles. They were meant to make
up for the dwindling supplies of new twenty- and thirty-somethings with
the education, jobs and family stability to spark and maintain a sustainable
housing boom.
September 11
Dem Blues
The housing boom seemed to Washington and Wall Street as answer to the
lack of 1990s-style economic stimulus from another technology boom.
Nasdaq Composite Index

You can’t have a January 1, 1992 to September 1, 2009
consumer boom 5,500
if your society’s
4,500
fertility rate is in
sustained decline. 3,500
2,500
1972.63
1,500
500
Jan-92 Jan-94 Jan-96 Jan-98 Jan-00 Jan-02 Jan-04 Jan-06 Jan-08
Japan, which as recently as 1989 was considered a threat to American global

economic pre-eminence, demonstrates two painful lessons for America:
• You can’t have an economic boom based on an industry that is in a Triple

Waterfall Crash;
• You can’t have a consumer boom if your society’s fertility rate is in sustained
decline.
There are many differences between America and Japan. One of the more
obvious is that, although the economy had been struggling since 1990, the
Japanese continued to vote for the party that had been in power nearly all the
time since the MacArthur era. Obama certainly doesn’t believe that he’ll keep
control of the White House and Congress if the economy doesn’t recover by
2012.
Last week, the Japanese showed they had finally had enough of not getting
enough economic progress.
The new government is promising change. However, unless the regime bravely
confronts the nation’s die-off, whatever policies it implements will fail.
Japan’s Triple Waterfall crash, which began 20 years ago, was driven by
demographic collapse, and its continuation proves the impossibility of
achieving a strong consumer-based economy when the supply of new
consumers declines every year.

Near-zero yield long government bonds may make headlines, but they don’t
offset the below zero replacement rate of babies. (At the peak, long Japanese
government bonds yielded 8%; yields fell more or less continually thereafter
and seem to heading asymptotically toward zero.) The Japanese decline from
global wunderkind status continues—twenty years after the Triple Waterfall The Japanese decline
peak. from global wunderkind
status continues—
Almost unnoticed by the seers, Japan became the model for most of the OECD,
twenty years after the
which took a decade longer to drive fertility rates far below replacement
Triple Waterfall peak.
levels—and keep them there. The US was the seeming exception to this
bleak picture of permanent decline: it was able, during the 1990s, to keep its
economy going by large-scale immigration, and from the higher birthrates
among minorities. (The contrast with Japan is striking: Japan is famously
opposed to offsetting its population decline through immigration.)
GDP is the sum of output per worker multiplied by the number of workers, less
the net foreign trade balance. Japan has always managed to maintain a trade
surplus as a partial offset to its desiccating demography. The consumer-led
recession has reduced the never-ending US trade deficit, but nobody thinks
the US could run trade surpluses to make up for weakening demography.
Nikkei 225 Index

January 1, 1982 to September 1, 2009
40,000
35,000
30,000
25,000
20,000
15,000
10,000 10,530.06
5,000
Jan-82 Jan-85 Jan-88 Jan-91 Jan-94 Jan-97 Jan-00 Jan-03 Jan-06 Jan-09
September 13
Dem Blues
Meanwhile, on mainland Asia, the contrast with Japan could hardly be more
impressive:
Shanghai Composite Index

...the combined GDPs
of China, India and 5,750
Brazil have grown
4,750
so rapidly that they
now represent 3,750
roughly one-fifth of
2,750 2,845.02
world output—
equal to the US. 1,750
750
Jan-02 Apr-03 Jul-04 Oct-05 Jan-07 Apr-08 Jul-09
Bombay Sensex 30
22,500
18,500
15,398.33
14,500
10,500
6,500
2,500
Jan-02 Apr-03 Jul-04 Oct-05 Jan-07 Apr-08 Jul-09
Were these Asian giants in US-style recessions, global financial markets would
almost surely still be in major bear patterns, and optimism about economic
recovery would be as rare as confirmed sighting of extra-terrestrials; industrial
commodity prices would be at levels challenging the financial viability of all
but the best-financed producers.
The major Asian economies, plus Brazil, (and not the USA), are collectively
the deus ex machina for all forecasts of a global recovery from the 2008 Slough
of Despond. According to economist Robert Samuelson, the combined GDPs
of China, India and Brazil have grown so rapidly that they now represent
roughly one-fifth of world output—equal to the US.

People entering the workforce make the difference.
According to the United Nations statistics, the only large economies with
positive fertility rates are India (2.8) and Indonesia (2.6). (The US rate is flat
at 2.1, down from 2.5 in 1970 and 3.5 in 1960. Other OECD fertility rates
...the ratio of new
for comparison purposes: France 1.9, Germany 1.4, UK 1.6, and Italy, Spain,
twenty-somethings
and Japan 1.3.)
relative to the
Consider recent US recoveries, and how they were stimulated by earlier number of new
fertility rates: seventy-somethings
1. Coming out of the 1982 recession, (22 years after 1960, when the fertility will continue its long
rate was 3.5). decline.
2. Coming out of the 1991 recession, (22 years after 1970, when the fertility
rate was 2.5).
There was some muted American cheering in December 2007, when the
government announced that, for the first time in 35 years, the fertility rate
had reached 2.1, which meant it had reached the population replacement
level.
That’s the good news.
The bad news is that the break-even level doesn’t do much for future economic
cycles because the ratio of new twenty-somethings relative to the number
of new seventy-somethings will continue its long decline. That’s not just
negative for the future of the homebuilding industry: it’s the fundamental
reason why US GDP growth in each new cycle will be constrained by the
costs of government benefits for the elderly—and by sustained shortages of
experienced skilled labor.
Perhaps this lengthy recital of population statistics is making readers’ eyes

glaze over, or, perhaps readers are objecting to our optimism about China’s
future when its fertility rate—at just 1.35 per woman—is far below the US
rate.
That perilously pitiful Chinese rate would, if there were no major counter-
vailing factors, prefigure future economic pygmydom for China, because it
is lower, from a reproductive maintenance standard, than almost any other
country. It comes, of course, from the single child policy. The population of
young males relative to young females is rising. If sustained indefinitely, it
would guarantee both a deeper plunge for future Chinese fertility rates and
the inevitable Japonization of China.
September 15
Dem Blues
However, China has time to reform its demographic policies, because it has
its own, nearly unlimited, supply of new young workers: the numbers of new
industrial workers and new first-time urban homebuyers will continue to
grow rapidly for at least the next 15 years because of inward migration from
The Old World, farms to cities. Demographers estimate that by 2025, China will have 1,000
therefore, has cities with a population of at least one million residents. That awe-inspiring
two distinct trend helps to increase Chinese GDP in two ways: it reduces the population
disadvantages of of farmers living on pitiful plots of one to three hectares, producing barely
dynamism compared enough food for themselves; they are sent to modern factories and stores
to the New World... in new cities, so there is increased output both of the former farms—which
become part of a much larger and more efficient agricultural base—and the
city, where the workers’ production is then measured in GDP.
This historically-unique large-scale inward migration that offsets demographic

decay through per capita GDP expansion isn’t open to the OECD nations
whose GDP is stalling out from demographic decay.
The Old World, therefore, has two distinct disadvantages of dynamism

compared to the New World in an age of worldwide industrialization:
1. The relative lack of babies who stimulate demand for homebuilding,

renovation and consumer spending now, while laying the foundation for
faster economic expansion later when they enter the workforce and form
their own families;
2. Their relative lack of inward migrants—who are already citizens, and are,
in general, more likely to be able to integrate rapidly and effectively into
their new environment than external immigrants from poorer countries
with language or cultural issues that can impair rapid absorption.
Admittedly, China and India have great internal challenges arising from
historic ethnic, language and cultural barriers, or from establishment of
control over regions and communities that historically rejected being
included within China or India. India’s occupation of Kashmir, a largely
Muslim state, is a costly drain on its military and financial resources. China
has problems with Tibetan and Uighur peoples who reject its overlordship.
However, among the billions of citizens in those societies, these problem
groups are, at worst, nuisances.

The US Recovery: Will It Be a V, U, W or X?
1. Questions about the Inventory Cycle and the Shape of the US Recovery
Economists who believe the US is already in a strong V-shaped recovery base The remarkable
much of their case on the reassuringly familiar mathematics of the inventory exception to this
cycle: when economies fall into recession, the net reduction in inventories is pattern has been
often the statistic that tips the economy over to negative growth. Similarly, crude oil.
once businesses stop reducing their inventories and make even modest
additions to fill up gaps in their warehouses, that turn from negative numbers
to even—or slightly positive numbers—is a relatively powerful snapback
number that signals the return of Happy Days.
Inventories are expressed in terms of sales months. So on the down cycle, even
though companies are cutting inventories, if sales are slumping faster, then
the inventory-to-sales ratio rises, forcing even more drastic stock reductions
in the following month. US Q2 numbers released last week showed that
inventory destocking remained a big negative for GDP. One client told us
recently of a major oil services company that had cut its inventories of a
particular line of equipment from four months to six days—in just seven
months.
Inventories respond to two forces: sales and cash needs. By making sales
from inventory and not replacing the materials sold, corporate cash is
generated—at a time when bank financing is problematic.
Conversely, when treasurers and their bankers are reasonably content with
the components of their corporate quick ratios, and, if there are signs of rising
prices, companies can see advantages in using cash to rebuild inventories.
What happened in this cycle was that deflationary forces stimulated panicky
liquidation of raw, manufactured and semi-manufactured goods, at a time of
corporate tail-chasing as sales kept plummeting, and treasurers tried to keep
their inventories in line with the falling sales.
The remarkable exception to this pattern has been crude oil. Until August,
the extremely steep oil contango was a huge inducement for oil refiners with
adequate finances to buy excess supplies of crude, and then find the tanks—or
tankers—to store it. That contango was assisted by the willingness of major
consumers to buy oil futures and options to hedge themselves against much
higher oil prices.
September 17
Dem Blues
In recent weeks, the contango has shrunk. The spread between spot crude and
December 2010 crude, which had been in double-digits, has now narrowed
to $6 a barrel. But the fact that there is no bargain-priced oil anywhere on the
futures curve despite declining OECD consumption remains a Damoclean
optimism...that we sword over all those confident forecasts that deflation is here to stay.
are about to be
Moreover, crude goods are not a major percentage of total inventories across
bathed in the
industrial economies. As long as prices of manufactured goods and parts stay
beautiful math bath
under pressure, wholesalers and retailers will be paid to stay lean.
of rising inventories
that make GDP look In other words, the near-universal optimism among US economists—that we
like it’s on steroids... are about to be bathed in the beautiful math bath of rising inventories that
make GDP look like it’s on steroids—is not the stuff that investors should
dream on—let alone invest on.
Of course, when—or if—prices of crude and semi-finished goods start to rise,

forcing manufacturers and wholesalers to begin restocking, then the US will
face a different kind of challenge. A new generation of bond vigilantes will
surely arise, and Ben Bernanke and friends will be forced to unveil their exit
strategy. How will Obama and the Congress respond to a rise in interest rates
if house prices remain low and unemployment remains high?
We have written previously about the Fed’s inflation time bomb. It still ticks,
although so softly one must incline one’s ear—and accept the raillery from
others who say that any sound is purely imaginary.
But inflation is tomorrow’s problem—investors have more immediate

concerns.
2. The Case from the Skeptics

Nouriel Roubini is the most publicly prominent of the small group of
“doomsayers” who correctly predicted the Crash and recession, based on
their prescience about the extent of the housing and financial collapses.
Writing last week in the Financial Times, he predicts a “U-Shaped” US recovery.

He argues that employment continues to fall, and that “this is a crisis of
solvency, not just liquidity, but true deleveraging has not begun yet because the
losses of financial institutions have been socialized and put on government
balance sheets. This limits the ability of banks to lend, households to spend
and companies to invest.” He is generally backed in this analysis by those
other two prominent prescients (who are personal friends), David Rosenberg
of Gluskin Sheff, and Stephanie Pomboy of MacroMavens.

Roubini’s case for a double-dip recession is also based, in part, on the fact that
oil and food prices are “rising faster than economic fundamentals warrant,
and could be driven by excessive liquidity chasing assets and by speculative
demand.”
...demography’s impact
David Rosenberg looks at the economic and chart data, and concludes that
has only begun to
the US is in the middle of a 18-year equity bear market and a long-term
challenge the idea
commodity bull market.
that bricks and mortar
We are sympathetic to this analysis, based on our experience during the are havens.
1970s. The commodity bull markets of that era were partly driven by the
weak returns from conventional equities, but also from investors’ growing
convictions that governments and central banks couldn’t cope with stop-go
economies, geopolitical shocks, and stubborn inflation.
Those who deride our bullish commodity views sneer, “So where’s the
inflation? Bond markets were collapsing in the 1970s and interest rates were
soaring, despite massive monetary creation. This time, central bank rates are
near-zero and even long-term Treasurys are trading at yields that assume no
real inflation for years to come. Inflation-indexed bonds are going nowhere
(although they do, of course, qualify for the real asset category in institutional
portfolios). Commodity consumption is falling almost everywhere except in
Asia, and those economies are all dependent on exports to the US and the
rest of the OECD, so unless the US and Europe recover strongly, raw material
prices will fall to new lows. As for rising gold prices, that’s just a bunch of
economic Neanderthals scaring people about a coming collapse of the dollar,
which won’t happen, because there’s no other currency to take its place.”
Our take on these criticisms:
1. The vigor of central bank response to the financial crisis makes the excess
monetary creation of the 1970s look positively penurious. Despite the
assurances from Chairman Bernanke, investors who look at the $9 trillion
US deficit projection for the coming decade are wise to hedge themselves
with hard-asset-based investments.
2. Real estate filled that function in earlier cycles, but demography’s impact
has only begun to challenge the idea that bricks and mortar are havens.
In earlier cycles, homeowners couldn’t get 100% financing even if they
had reliable employment records. This time, the overbuilding is of scary
proportions. The reliable Dennis Gartman last week cited a report from a
research firm that says “15.2 million of American mortgages or just over
32% of all mortgaged properties were ‘upside down’ as of June 30th.”
September 19
Dem Blues
It’s not just the subprimes, AltAs and all the [Barney] Frankly foolish
loans that are in trouble: a big chunk of conventional mortgages are as
well, thanks to Fan, Fred and the Federal Home Loan Banks. The Boomers
wiped out in the tech-mania apparently decided in this decade that the
...retail investors only sure-fire investment left was residential property, and they rushed into
collectively have been it with gusto. The pricking of that bubble has discredited residential real
bailing out of gold estate as an inflation hedge for years to come. And as for all those pension
jewelry as fast as they funds which rushed into commercial real estate, the consequences of the
buy bullion... pricking of that overlevered bubble have only begun to spread across the
US economy.
3. Those reassuring long-term Treasury yields are, in significant measure, the

product of Bernanke’s purchases, and the continued willingness of Asian
economies to maintain their currencies’ relationships with the dollar.
Now that the world knows that the current US deficits have morphed from
temporary to permanent, prudent investors may decide that some other
long-term bet makes good sense. The 3.3% yield on the 10-year Treasury,
which has meant low mortgage rates, was the key factor underlying last
week’s report that, for the first time since the troubles began, house prices
actually rose slightly in June. What happens when overseas investors
conclude that they aren’t being paid enough—in a dubious currency—to
finance the endless deficits? As for TIPS, they’re dollar-denominated, so
they have deep endogenous risk, albeit with a built-in hedge that becomes
increasingly difficult to quantify.
4. Yes, commodity prices are ultimately driven by supply and demand. But
most analysts project higher long-term prices for oil and metals, for reasons
we’ve set out in Basic Points too often to recite anew. As for the grains,
China, with some serious drought problems, is buying US soybeans like
there’s no tomorrow, and India has announced it will offset any shortfall
in domestic food production with purchases from its exchange reserves.
As we’ve noted above, the only rational debate about the next global food
crisis is when it will arrive.
5. Finally, as for gold, retail investors collectively have been bailing out of
gold jewelry as fast as they buy bullion, so this isn’t a consumer inflation-
fear bubble about to burst. Central banks have long since ceased trying to
sell all their “excess” gold holdings. As club members, they aren’t about to
swap Treasurys for gold, but China has modestly boosted its gold exposure,
and the next global recovery will almost certainly shift investor perceptions
of the relative attractions of paper money to precious metals.

However, as the crash last year demonstrated, if the US financial system
implodes anew, prices of commodities and commodity stocks will also
plunge. What that debacle unleashed was the unwinding of exposures to all
marketable risk assets and the forcible deleveraging of dollar-denominated
debt across the financial system, driving the drooping dollar into a sudden The H1N1 flu is
rally. gaining strength
across the US and
US Dollar Index (DXY) much of the world.
90
86
82
78 78.51
74
70
Jan-08 Mar-08 May-08 Jul-08 Sep-08 Nov-08 Jan-09 Mar-09 May-09 Jul-09 Sep-09
During the horrendous bear markets for equities, currencies, corporate

debt, and commodities, “The China Story” became just another suddenly-
discredited investment concept. How could China continue to grow when
its exports collapse?
Suppose that, by late winter, the US economy’s green shoots appear to have
been largely buried. Bernanke’s options are limited—Japanese-style—by
zero-interest rates. Congress, still smarting from voter rage at bank bailouts,
cannot agree on further stimulus packages. Mortgage foreclosures keep
climbing, along with unemployment.
This is, essentially, the SuperBear thesis.
We would add one other factor to that grim foreboding: The H1N1 flu is
gaining strength across the US and much of the world. The National Institutes
of Health is warning health care providers, governments and businesses that
it will likely become a serious threat to the US economy before the season for
routine flu peaks in winter.
Add in the strong possibility that Iran successfully tests a nuclear bomb,
and the US Administration, under pressure from Congressional Democrats,
announces it cannot schedule new troop allocations for Afghanistan for the
reopening of the fighting in Spring.
September 21
Dem Blues
Obama’s approval ratings could well sink to late-Bushian levels, and polls
would show a big swing to Republicans for the 2010 mid-term elections,
even though the Republican Party would still lack a leader.
That concatenation of economic, strategic and financial challenges would

...the money supply
be a replay of the gloom in the 1970s that destroyed the British Labour
isn’t growing as fast
government, elected Thatcher, destroyed the Ford Presidency and elected
as, say, corn: indeed, in
Carter. By mid-1982, US stock prices were at new 18-year lows.
the past four months
the annualized We certainly doubt that all that bad news will come to pass, but remain
growth of M-2, concerned that the stock market has been throwing caution to the winds.
(0.6%) more closely
We still cling to the hope that the economy will bottom out, Asian strength
resembles the growth
will continue to shrink the trade deficit, and that housing will not drag
rate of a cactus...
the rest of the economy down forever. The sheer scale of global monetary
liquification and bailouts argues against a new plunge into a deeper abyss.
But, the critics ask, why is most of the Fed’s extra monetary creation sitting
on its balance sheet, having been recycled back to the Fed from the banks,
which choose not to use it in making further loans? In effect, according to
this analysis, the liquidity gain is a mirage: now you see it, now you don’t.
The critics have a good point: despite the trebling of the Fed’s balance sheet
and the continuation of near-zero fed funds rates, the money supply isn’t
growing as fast as, say, corn: indeed, in the past four months the annualized
growth of M-2, (0.6%) more closely resembles the growth rate of a cactus; since
June it’s actually been negative (-3.6%). Investors assumed that Bernanke was
following the Friedman formula of inducing M-2 growth above normal GDP
levels to offset recessionary pressures. The data of recent months suggest that
Roy Young, (Fed Chairman from October 1927 to August 1930) might have
returned from his justly-earned obscurity and his unremarked grave.
However, it could be that Mr. Bernanke is up against the same monetary

challenge the Bank of Japan faced: the Zero barrier. How do you set and
manage negative interest rates? Well, Sweden’s Rijksbank is experimenting
with negative yields on reserve deposits, as a goad to bankers to do something
with the reserves the Bank has created. The top man in Stockholm is an old
school friend, we are told, of Ben Bernanke, so just maybe the Fed will try
that strategy too. “We will do whatever it takes” is the Bernanke motto.

Perhaps the only reassuring statistic that suggests monetary policy is working
is the steep yield curve. That is financial adrenaline for the comatose
banking system. Combined with the capital infusions and the excess reserves
sequestered on banks’ balance sheets (even though the money has been
recycled back to the Fed), we are inclined to accept Bernanke’s cautiously How much should a
optimistic assessment that the system is in the early stages of healing from its bank boss be paid for
massive self-inflicted wounds. attracting government-
guaranteed deposits
But as long as the banks choose to leave so much of their reserves frozen
and then shipping
with the Fed, it’s hard to see anything approaching a V-Shaped recovery.
them to the Fed for a
(It’s also an argument the Congress could consider when it’s considering
microscopic return?
appropriate compensation for bankers. How much should a bank boss be
paid for attracting government-guaranteed deposits and then shipping them
to the Fed for a microscopic return?)
Maybe it’s a “U” or maybe a “W”, but it will certainly bear no resemblance
to China’s profile.
The more sluggish the recovery, the more the gap between “Chindia” and the
US closes.
The Grains Again

Although we are hardly happy with the current state of the US economy,
not all the US economic data are doleful. The US remains the world leader
in agricultural output and profitability. Those Asian tigers have voracious
appetites for protein, and American farmers, whose productivity continues
to rise relentlessly, are, at least for now, the world’s best hope for averting a
catastrophic food crisis.
On that front, the news would seem reassuring:
Corn
850
750
650
550
450
350 319.25
250
150
Jan-05 Sep-05 May-06 Jan-07 Sep-07 May-08 Jan-09 Sep-09
September 23
Dem Blues
Wheat
1,100
...global carryovers 950
of feed grains will 800

actually decline 650
this year, despite
500 487.25
a bumper year
350
for US crops.
200
Soybeans
1,600
1,400
1,200
1,000 955.50
800
600
400
However, the USDA reports that global carryovers of feed grains will actually
decline this year, despite a bumper year for US crops. Wheat and soybean
carryovers will increase.
The sudden financial crisis slashed grain prices in two ways:
• Grain speculators and—more importantly—commodity funds—were

forced to slash exposures to the key traded grains;
• Shocked Asian consumers cut back their demand for meat and vegetable
protein.
The grain rallies this Spring came in response to the unusually cold winter
and late planting season across the Upper Midwest. However, using high
technology, farmers got their crops planted in remarkably quick time once
the downpours ceased.

What was then feared was that the small green shoots would etiolate under
the expected blistering heat of July. Then July turned out to be one of the
coolest on record across much of the Upper Midwest. With lots of rain, the
crops flourished wondrously. Now, the only weather change that could avert
a barn-bursting harvest would be a killing September frost. ...the sun did
almost nothing this
The same dry, cold Arctic highs that came steadily down to the Midwest to
summer—spotwise.
meet the hot air from the Gulf, producing those heavy rains, dried out large
areas of the Canadian prairie wheat and canola farmland en route; drought
conditions in much of Western Canada reached serious levels. Across other
parts of the world, the erratic weather conditions have been frequently
farmer-unfriendly this year.
In particular, the Monsoon—India’s large-scale equivalent of the Nile—was,

until last week, a large-scale disappointment this year. Rains have been
adequate in the south, but have been inadequate in the middle and north of
the subcontinent. These variations are what one might expect from a weather
system based on the varying temperatures across the Arabian Sea at a time
of somewhat cooler global temperatures. The most-publicized result to date
is the sky-high price of sugar: India is the world’s second largest cane sugar
producer and the world’s biggest sugar importer.
Nonespots?
We have mentioned this year’s unusual weather conditions in several places
in this essay.
We conclude, therefore, by updating our observations on the sun.
The short answer is the sun did almost nothing this summer—spotwise. Until
this week, there had been no sunspots for 50 days, and overall solar activity
this year still could be the lowest in nearly a century. If this solar silence lasts
another year, astronomers will be forced to recalibrate their forecasts.
No mainstream astronomer predicted such a lapse in solar activity. NASA has

long maintained its estimate that, since the dawn of the Industrial Revolution,
sunspots have accounted for roughly 40% of the observed increased in global
temperatures—the rest came from anthropogenic sources.
But nobody really knows.
September 25
Dem Blues
Clients interested in further information can consult our website, where

we post material on the sunspot and climate change debate from reputable
scientists.
Since we began writing on this subject, there has been an observable decline
Despite its recent
in world temperatures and an observable increase in ice at both poles. But
robust rally, the S&P
no one can prove that the small amount of cooling most of the planet has
is today lower than
experienced is caused by the dramatic collapse in sunspot activity.
it was a decade ago.
There is no gainsaying that, based on more than four centuries of evidence,
sharp, sustained declines in sunspot activity have been accompanied by
sharp, sustained periods of global cooling. But the scientific community
takes the position that no causation has been proved, so the relationship
between extra heat from the sun and extra warmth on earth could have been
purely coincidental.
If war is too serious a business to be left to generals, the sun’s effect on

earth’s climate could be too important an issue to leave to the astronomers
and environmentalists. Governments are betting trillions to fight global
warming, when a more serious climate problem could be emerging. The
global warming we’ve had to date has been mostly food-friendly—longer
growing seasons.
A return to the world’s cold weather of the 17th and 18th centuries before the
current sunspot cycle arrived would be a major challenge for global food
production.
So we continue to believe this seemingly arcane issue is worth following.
Bonds As The Right Trade Now?

Hinges of History are traditionally times of above-average risk—and
potentially above-average reward for investors.
Despite its recent robust rally, the S&P is today lower than it was a decade
ago. Its behavior recalls the disappointments of the 1970s. Stocks finally
broke out of their 16-year bear market with the Reagan Rally. On the day
before Volcker finally declared victory against inflation and began slashing
rates, the Constant-Dollar Dow was back to late-1929 levels, erasing 53 years
of widely-cited evidence that stocks were the asset class that would always
outperform inflation.
Remember that those 53 years were also the era in which America was the
world’s leading economy, and included the period from 1944 in which it was
also the world’s strongest military power.

We have few clients who were practicing investment professionals during
the 1970s. The Cult of Equities became Wall Street’s enthusiasm during the
Reagan-Thatcher years and became a secular religion during the late 1990s,
as business schools disgorged hordes of true believers.
With the deified
Corporate pension funds had long relied on fixed income investments, but
Alan Greenspan’s
began diversifying into equities during the go-go Cornfeld era. By the 1990s,
imprimatur,
capital asset valuation models were marginalizing bonds, as the conviction
The Pension Benefits
grew that long-term investors would always be paid for assuming greater
Guaranty Corporation
risks.
reluctantly accepted
Almost unnoticed was the gigantic contribution to total returns from the those giddy
multi-decade drop in long bond yields. When FASB 87 was imposed on valuations...
corporate pension funds, the rule for projecting future returns from asset
classes was the retrospective return each class had delivered in the previous
five years—or longer. We recall the debate about the financial viability
of major corporate pension plans during the early years of this decade.
Some major companies—such as IBM—were able to dismiss their critics
who ridiculed the assumed 8% annual projected rate of earnings on their
investment quality bonds by pointing out that 8% is what they’d earned
on their bondholdings since 1990, so that was a reasonable expectation for
the future. Problem: Long Treasurys yielded as much as 9.5% in 1990, but
the yield fell as low as 5% in 1998 and by 2002 were 4.5%. The companies
noted that the returns from holding a long noncallable bond from 1990
were spectacular, but made no mention of the obvious fact that they could not
be replicated in this decade unless rates plummeted to Japanese levels.
With the deified Alan Greenspan’s imprimatur, The Pension Benefits Guaranty
Corporation reluctantly accepted those giddy valuations—and corporate
America’s reported per-share earnings swelled agreeably.
Treasurys have decisively outperformed US stocks over the past 10 years. That
challenges the basic capitalist principle that equities must outperform over
the long-term, or a private enterprise economy cannot exist: wise investment
in economically risky assets has to deliver better results than owning
Treasurys.
Because we (perhaps stubbornly) continue to believe that risk will be

rewarded, we have, for most of this decade, recommended overweighting in
equities compared to bonds, and have also recommended below-benchmark
durations.
September 27
Dem Blues
Yes, we wish we had changed those recommendations 14 months ago.
Nevertheless, after such a robust run for equities, and after considering the
economic and political risks discussed in this journal, we believe a trade into
high-quality noncallable bonds makes sense. If all goes well, we’ll have a
We repeat our long-held
V-shaped recovery and bonds will underperform.
view: this is a cyclical
bull rally within a But if we experience a US double-dip recession, long Treasurys (and long-
secular bear market. duration high-grade corporates and munis) will once again move to the head
of the class.
At that point, we would expect to reverse the trade. Fortunately, bond trading
is not a costly undertaking, and investors can add to their exposures and
change their durations with a few keystrokes.
And they can reverse those trades if—or when—the stock market has corrected
and today’s most bullish strategists are wringing their hands.
Our recommendation is hardly extreme: it reduces equity risk and builds in

greater recession protection without violating the concept of investing for
the long-term with an equity bias.
We repeat our long-held view: this is a cyclical bull rally within a secular bear
market. US political and financial excesses have been so great that it will take
time—and political wisdom—to put the economy and stock market on a
sustained, noninflationary growth pattern.
Fortunately, the 1970s show us that equity investors can still earn good returns
despite double-dip recessions, bad politics, and loose monetary policies: by
owning well-managed commodity-producing companies.
Forgive us if we review two painful times in our career when this strategist’s
lot was not a happy one.
We suffered the worst experience of our career from early-1999 to late-2000.

Having said Nasdaq was seriously overvalued at 2600, we were ridiculed in
many circles as Nasdaq responded to Greenspan’s frantic liquidity injections
by doubling in months. Our sustained criticism of tech companies’ multiples
and earnings statements because of (1) the ease of competitive entry into
more and more tech product lines, and (2) their refusal to account for stock
option costs, was a costly call.
What about last year’s Crash? Wasn’t that an even greater humiliation for a
commodity bull?

It was profoundly painful, but the difference, we believe, is that real stuff
will always be worth something—and commodities had already had their
Triple Waterfall Crash from 1980 to 2001, which meant that their debt to
society—and investors—was paid, and the survivors had learned to control
their capital expenditures. Moreover, the emergence of China and other Asian ...real stuff will always
powers as major economic forces meant that commodity demand would be worth something...
grow faster than OECD GDP during this decade. The world was changing
in a way that was commodity-friendly, and we never changed in our view
that scarcity would eventually return. Moreover, the continued shrinkage
of unhedged reserves in the ground in politically-secure areas of the world
would undergird the valuations of the well-managed companies. This was not
a replay of the tech bubble, because tech companies grew through sustained
sizable increases in sales of units, whereas mining and oil companies’ ability
to grow units of output was constrained both by capital and by availability
of low-political-risk, high-quality reserves.
We still believe that.
Despite the violent commodity selloff, few raw material prices are back
to levels at which efficient producers cannot earn profits. The industries
continue to consolidate into ever-stronger hands. Consider how quickly
the mining majors cut back on copper production when copper broke $2
a pound. Notice how firm the producers are as unions increase their wage
demands.
Notice also the trend we have been discussing toward the new autarky,
as major commodity-consuming countries make acquisitions of mines
and oilfields across the world. Again quoting Niall Ferguson: “[Chinese]
investments in African minerals and infrastructure look distinctly imperial…
And now the official line from Prime Minister Wen Jiabao is to ‘hasten the
implementation of our ‘going out’ strategy and combine the utilization of
foreign exchange reserves with the ‘going out’ of our enterprises.’ That sounds
like a Chinese campaign to buy up foreign assets—exchanging dodgy dollars
for copper mines.”
There is, quite simply, no way that the Newly Industrializing Economies
can continue to narrow the gap between their inhabitants’ incomes and
expectations and the wealth of the OECD countries without continued
increases in consumption of commodities.
September 29
Dem Blues
Investors’ preoccupation with the outlook for the US economy could mean
missing the reality of where the world’s economic power is heading. Yes,
the US remains the biggest economy in the world, but it is also the only
huge economy in which consumer activity is 70% of GDP—at a time when
...most of these consumer debt is roughly twice the level of consumer income. The utterly-
“savings” are inevitable reduction in consumers’ willingness to take on more debt to
ephemeral: they buy more stuff means that Thrift is a menace to prospects for a sustained
go to pay down recovery.
debts for previous
The optimistic talk that the recent increase in the personal savings rate is the
consumption.
precursor to the next consumer spending boom ignores the reality that most
of these “savings” are ephemeral: they go to pay down debts for previous
consumption. They aren’t the stuff of real savings in the form of investments,
401(k)s and other provisions for the future—which is coming fast for over-
indebted Boomers.
We now know that the Boomers whose savings were wiped out in the tech
collapse collectively made the seemingly rational decision that they would
make up for that disaster by investing heavily in housing—the only asset that
had never gone down in price. It took the form of buying bigger houses than
empty-nesters needed, buying Sun Belt homes for their retirement bliss, and,
when the speculative mania began, to buy extra houses, flip condos, and
buy other highly-leveraged “investments.” Despite the horrors of house price
collapses, a current Rasmussen poll reveals that 59% of Americans believe
that buying a home is the best investment a family can make. It would appear
that the average American has been burnt too seriously in the two major
equity bear markets of the past decade.
As for Americans’ rush from stocks to housing, those disastrous Boomer

strategies were employed—on even grander scale—in countries whose
demography was worse than America’s, such as Britain, Ireland and Spain.
(We learned on a trip to London in 2008 that house prices in windy, wet
Wales were up 40% in 2007, and wondered when this bubble would burst.)
In Eastern Europe, many of the formerly Communist countries with

desperately depleted demographies adopted the new wisdom with gusto.
They found they could get mortgages denominated in Euros at much
lower rates than their cautious central banks were providing in their own
currencies.

The Germans resisted this trend, and continued in their stolid savings, and
constrained consumption habits.
No surprise that Germany is rapidly emerging from its recession, with many
of its factories humming on exports to Asia.
Citigroup—a giant
Although most of the press commentary about the big stock market recovery multi-strategy hedge
is about the sharp rally on Wall Street, Emerging Markets shares have fund run by a hedge
generally outpaced America’s. Some of these markets are looking pricey, but fund manager...
not in comparison with the S&P—and certainly not in comparison with
speculative low-priced US stocks. Chats with value-oriented US investors
confirm our view that the leadership in the US rally comes from the riskiest
class of stocks—small, over-indebted, and driven by the Audacity of Hope
of Outsized Gains. Citigroup—a giant multi-strategy hedge fund run by a
hedge fund manager—shot up 70% this summer and frequently accounted
for 10% of NYSE volume. Even Fannie Mae and Freddie Mac—the Frank
Zombies—are outpacing the broad market. Last Fall’s excessive Fear is became
this summer’s excessive Greed.
Except among insiders: month-after-month, corporate insiders have been

selling far more of their companies’ shares than they’ve been buying. In
August, they sold 30 times as much stock as they bought. What do the bosses
know—or fear—that economists, strategists and retail investors don’t?
The S&P rally from its low is huge compared to past leaps from recession
lows, and is comparable even with the storied Depression rally that was
followed by a collapse to new lows. Although we believe that the US stock
market rally has been overdone, we are not in the “Depression likelihood”
camp for the following reasons:
1. The Bush-Bernanke-Obama responses are cumulatively gigantic compared

to monetary and fiscal interventions then.
2. The signs of renewed US protectionism are mostly limited to meeting

union demands—such as to ban Mexican truckers, reject the free trade deal
with Colombia, and include “Buy American” clauses in state-sponsored
infrastructure projects. Obama and his close advisors aren’t Bush-style free
traders, but they also aren’t Smoot and Hawley in sheep’s clothing.
3. Regional bank failures are growing, but they aren’t comparable to

Depression numbers.
September 31
Dem Blues
4. One beneficial temporary effect of demographic decline is that the number

of young people leaving school and entering the workforce for the first
time isn’t skyrocketing the way it did during the years when female fertility
rates were very high—in the Depression, and, for that matter, in the years
Zero return money before the deep recession of 1974-75, when young unemployed males
market funds are were rioting across Europe.
invitations to investors
5. Government income transfer payments are now large in relation to both
to take on excessive risk.
employment income and GDP compared with Thirties levels.
6. Back then, Europe entered recession first, followed by the US and as the
downturns accelerated, signaling a world Depression. This time, the US
went down first; France and Germany are apparently emerging from
recession, and most of the leading Third World countries have either
escaped recession or are emerging from it, so a Global Depression is an
extremely remote probability.
7. The 2008 commodity price collapse didn’t take raw material prices back
to Triple Waterfall Crash levels. Most of the key commodities—including
the grains—are at profitable levels for most farmers—with pork being the
most conspicuous exception.
8. Gold’s upward revaluation this time means that central banks collectively
have modest gains in asset values. Roosevelt unilaterally raised gold from
$20.67 to $35.00 in 1933—which may have been his most successful
recovery program.
9. The US prairies aren’t experiencing disastrous dust bowl conditions

arising from extreme heat, as they experienced in the Depression. Grain
Belt temperatures generally have never gone back to those heights, even
during the years in which global warmists were shouting that we faced
frying. And this year is among the coolest since records were kept across
much of the Upper Midwest.
Nevertheless, we are of the opinion that US stock prices are rallying far faster
than the recovery is progressing because of the Bernanke Liquidity Gush
which maintains short rates in the zero range. Comparing this rally to the
Reagan Rally—which was the real thing—is somewhat illogical: back then,
short rates, even after the rally was building steam, were in the high double
digits, which meant investors had high returns on risk-free investments. Zero
return money market funds are invitations to investors to take on excessive risk.

We are currently of the view that there will be a stock market correction that
will turn many of today’s snorting bulls into bear cubs.
We also remain wary of the behavior of the dollar. It is so much stronger

than conditions warrant, and the future embedded deficits are so far beyond ...there will be a stock
any experience that we cannot assume that thrifty foreigners will continue to market correction
write blank checks to fund such scary profligacy. The Treasury now auctions that will turn many of
more most months than it used to auction in a year. At some point, buyers today’s snorting bulls
will demand higher—perhaps much higher—rates. A whiff of higher rates into bear cubs.
could be the anesthetic that sends the bull to dormancy.
In the meantime, a quasi-recession bond structure reduces a balanced

portfolio’s endogenous risk, without slashing equity exposure unduly.
We aren’t real economic bears: we believe that the stock market is over-
optimistic and will correct soon.
That will be a buying opportunity and will be a time to cash bond profits.
September 33
Dem Blues
RECOMMENDED ASSET ALLOCATION
Recommended Asset Allocation

(for U.S. Pension Funds)
Allocations Change
US Equities 17 -1
Foreign Equities
European Equities 5 -1
Japanese and Korean Equities 2 unch
Canadian and Australian Equities 11 unch
Emerging Markets 14 unch
Bonds
US Bonds 12 +4
Canadian Bonds 8 +3
International Bonds 11 unch
Long-Term Inflation Hedged Bonds 10 unch
Cash 10 -5
Bond Durations
Years Change
US 5.25 +1.75
Canada 5.00 +1.25
International 4.50 +1.00
Global Exposure to Commodity Stocks
Change
Precious Metals 33% unch
Agriculture 33% unch
Energy 22% unch
Base Metals & Steel 12% unch
We recommend these sector weightings to all clients

for commodity exposure—whether in pure commodity
stock portfolios or as the commodity component of
equity and balanced funds.

Dem Blues
INVESTMENT RECOMMENDATIONS
1. Upgrade equity portfolios to reduce endogenous risk. Trade upward in

quality, and, in balanced accounts, increase bond exposure. There is, at
present, too much froth for comfort. After the grandest recession /recovery
stock market rally on record, this is hardly a good time to commit new
money into equities.
2. Emphasize Canadian stocks in North American portfolios. Canada has

the best banks, and the best range of commodity-oriented stocks. And it
has the best North American currency.
3. Continue to overweight commodity-oriented companies in diversified

equity portfolios. They have been underperforming the US market since US
stocks began to reach the top of the troposphere, and their most volatile
and gaseous members soared into the stratosphere. If the economic bulls
are right, commodity prices will soar. If it takes more time—and some
signs of restraint in Washington—to launch a sustained US recovery, then
commodity stocks will have the attraction that comes from producing
goods priced by the new Asian economic leaders.
4. The regional banks index (KRE) has not participated in the broad rally
recently, and is sharply underperforming the S&P, mostly because of
widespread construction loan losses. The BKX has more than doubled
since March, but it is dominated by the banks that got the most help from
Washington, so we have trouble seeing that steroid-based performance
as the signal to buy stocks. Until the KRE starts to show good relative
strength, the rally remains suspect, and investors should be lightening up
on financial stocks.
5. Until this week, gold had been range-bound this year, so gold shares
sharply underperformed the market. On Tuesday, bullion staged a sudden
upside breakout from its pennant pattern, which could signal a sustained
move through $1,000. As we were going to press, it had moved through
$990. Gold shares are attractive havens, because gold is the only asset
that can be expected to outperform under both extreme scenarios—
financial collapse and runaway inflation. Remain overweight gold within
commodity-oriented portfolios.
6. Whether by coincidence or otherwise, crude oil has been trading rather

closely to the S&P. Oil consumption statistics do not support a valuation
of $70 for crude oil. We recommend caution on oil stocks here.
September 35
Dem Blues
7. Natural gas is, along with pork (but not of the Washington variety), the
most conspicuous loser among the commodities. Technology, (in the form
of large-scale application of new techniques for developing huge shale
gas deposits) and cool summer weather have depressed gas prices. Even
a cold winter may not be enough to get gas prices to levels at which most
producers could show good profits. Underweight gas-prone companies
in commodity portfolios.
8. The prospect of record US corn crops has depressed the price of agricultural
companies’ shares. However, the food sector remains the least cyclical
and speculative of the main four commodity stock groups and should
be emphasized. We are still only one big crop failure away from a global
food crisis.
9. The bull market in corporate bonds has narrowed spreads remarkably. In

effect, virtually all risk classes have been in simultaneous bull markets—a
sure sign that liquidity is the basic driving force. The steep yield curve argues
for longer durations in bond portfolios, but unmistakable proof that the
US had emerged from recession risks would send investors scurrying to
midterms and force Bernanke’s hand. Since we think a V-Shaped recovery
is the least likely outcome, we now recommend increasing bond durations,
and are reversing the trading recommendation issued in June, when we
were increasing our recommended equity exposure in line with our view
that both the bond and stock markets were going to price in an economic
recovery. The stock market did: the bond market didn’t.

© Coxe Advisors LLC 2009. All rights reserved. Unauthorized reproduction, distribution, transmission or publication
without the prior express written consent of Coxe Advisors LLC (“Coxe”) is strictly prohibited. Coxe is an investment adviser
registered with the U.S. Securities and Exchange Commission. Nothing herein implies that the firm is recommended or
approved by the United States government or any regulatory agency.
Information, opinions, estimates, projections and other materials (referred to collectively herein as, “Information”) contained
herein are provided as of the date hereof and are subject to change without notice. From time to time, Coxe publications
may contain Information with regard to securities, commodities, derivatives or other investment assets (each referred to
herein as an “Investment,” or collectively, the “Investments”), or investment strategies. Due to staggered publication dates,
any Information contained herein may differ from Information contained in prior or subsequent publications. Information
discussed herein may have been obtained from various unaffiliated third party sources believed to be reliable, but has not
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takes no responsibility for any errors and omissions which may be contained herein, and accepts no liability whatsoever for
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Published by Coxe Advisors LLC
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BMO Capital Markets Disclosures

Author: Don Coxe 312-461-5365

Editor: Angela Trudeau 604-929-8791

Coxe Advisors LLC. www.CoxeAdvisors.com

That’s what most of the major indicators—ISM, Leading Economic Indicators

This month, we update major cautionary themes we have been discussing in

Each week, we read analyses from strategists and economists comparing

• it is the first to hit North America and Europe in which deteriorating

This month’s title is a riff on America’s unique music form. We use it to

Given that outlook, we think balanced portfolios should reduce endogenous

2 September THE COXE STRATEGY JOURNAL

4. Germany emerged as the industrial and military challenger to Britain.

4 September THE COXE STRATEGY JOURNAL

It was inevitable that Germany would eventually challenge Britain for

Who’s next at the top?

This recession has put that process on fast-forward.

History suggests that America’s unchallenged military pre-eminence will

The Turning of the Page

President Hu Jintao lacks President Obama’s eloquence, but his progress in

6 September THE COXE STRATEGY JOURNAL

Nixon’s disgrace, the Ford interregnum, commodity shocks, and stagflation

Fortunately, a President the elites ridiculed as a B-Movie actor managed to

So we should, perhaps, be cautious about assuming the US is on its way to

When will that happen?

Thinking About Tomorrow

However, although most economists believe the US has already emerged

• jobless claims, which had been declining week-by-week, suddenly upticked

• bank lending for economic activity isn’t growing;

• foreclosures keep increasing;

• the stimulus of extremely cheap gasoline is fading with the doubling of

• state and municipal governments are collectively in crisis, led by California,

• the Pelosi-Obama stimulus program turned out to be a perfumed

8 September THE COXE STRATEGY JOURNAL

Enter Dem Blues.

Don’t throw the past away

In actuality, while the spending orgy on yesterday’s priorities was convulsing

Those uplands gambolers of the future would be protected by a health plan

What a difference three months make.

The real sickness is in health care reform. Despite almost-daily Obama

The shock to Obama and the Congressional Democrats came in August,

10 September THE COXE STRATEGY JOURNAL

The Birth Control on Economic Growth

Backed by powerful Congressional Democrats through Fannie Mae and

Nasdaq Composite Index

Japan, which as recently as 1989 was considered a threat to American global

• You can’t have an economic boom based on an industry that is in a Triple

12 September THE COXE STRATEGY JOURNAL

Nikkei 225 Index

Shanghai Composite Index

14 September THE COXE STRATEGY JOURNAL

That’s the good news.

Perhaps this lengthy recital of population statistics is making readers’ eyes

This historically-unique large-scale inward migration that offsets demographic

The Old World, therefore, has two distinct disadvantages of dynamism

1. The relative lack of babies who stimulate demand for homebuilding,

16 September THE COXE STRATEGY JOURNAL

Of course, when—or if—prices of crude and semi-finished goods start to rise,

But inflation is tomorrow’s problem—investors have more immediate

2. The Case from the Skeptics

Writing last week in the Financial Times, he predicts a “U-Shaped” US recovery.

18 September THE COXE STRATEGY JOURNAL