Events this spring have increasingly revealed that the global recovery is extremely fragile and deflationary forces are still gathering strength. We continue to be locked in the downward phase of the long-term inflationary roller coaster that began decades ago. This is a classic boom-bust cycle with increasing tendencies to move out of control. Over time, the economy requires larger doses of money and credit to get the next upward phase going. Because the size of the recent bust was so big and the residue of stranded debt so high, it will require extraordinary amounts of monetary stimulus and credit increases over a lengthy period to generate renewed expansion on a significant basis. This will eventually cause faster inflation and another bubble, which will repeat the cycle.
So far in the current post-bubble environment, near-zero interest rates and massive liquidity injections from central banks have not helped the economy gain much traction. Growth remains weak and some countries are in recession, others in depression. This is the legacy of the post credit-bubble deleveraging, which probably has years more to run because debt levels remain untenable. That is why monetary policy has been essentially neutralized.
Massive uncertainty surrounds virtually every major issue facing investors. The eurozone remains a slow moving financial train wreck on the brink of a messy breakup. China is showing ominous signs of rapid deceleration and it is too soon to be sure of the timing of the next economic acceleration. We have recommended that investors remain cautious since the beginning of 2012. The key question is whether the current sell-off, which has seen an 8% decline the in the S&P since early April, now constitutes a buying opportunity or whether further weakness lies ahead.