US fund managers Comstock Partners reported a 50+% gain on their flagship Capital Value Fund in 2008. The logic behind their out- performance is summarised in the chart, which depicts their belief that we are now in a global cycle of deflation. Their analysis is that this cycle:
• Began with a rise in savings in emerging countries such as China, which then funded over-investment locally whilst also supporting excess consumption in the West.
• In turn saw twin excesses appear, of debt, and manufacturing capacity. These then led to the generalised weakness in pricing power now impacting chemicals and other major industries.
Some countries, such as the UK, have already responded to recent developments by devaluing. The pound is down 23% versus the US$ since September, and 13% versus the €. The risk is that we now see a round of competitive devaluations, as other countries also try to support their exports, and reduce import penetration.
Logically, countries should instead be focused on closing capacity as fast as possible, to avoid the menace of deflation. This would, of course, be very painful in terms of immediate job losses. But the risk, as Comstock suggest, is that we may end up seeing a rise in protectionism to protect employment, with governments imitating the 1930s by introducing tariffs and other beggar-my-neighbour trade policies.
Past performance, as we all know, is no guarantee of future performance. But there seems to be sufficient evidence for Comstock’s analysis to make the blog concerned that they may just be right.