The sad answer to the question of who loses in a deflationary mess is pretty much everyone. We have prepared ourselves and our investors for this for many years and have avoided credit risk and have been void of equities for quite a while, but we may still feel the pain.

As the credit market implodes (and I am serious when I say implodes—the credit market is now taking on that surreal ‘1-800’get-me-out’ feeling), think of who owns all of this debt. Retail investors around the country have been force-fed preferred shares that now trade at a mere fraction of their issue price. Fannie and Freddie preferred shares trade near $0, so one can only imagine how folks will feel when they open their brokerage statements in early October only to find their preferred shares they bought last year at $25 are at $1. Or if you owned a closed end bond fund that consists of leveraged municipal bonds (municipals are getting destroyed as well lately), preferred stocks or equities. These prices also have been annihilated and I can only imagine how little these folks will want to run out and buy a new car or plasma TV or Blackberry. One can see how this will now affect retailers, airlines, restaurant chains and anyone else that provides all but the necessities.

Other losers include fixed income investors that thought they were prudently investing funds in ‘high grade corporates’ like all of those that are now either in default or trading as if they are in default. Many of these investors are large insurance companies that buy long-term bonds to match up their assets and liabilities. As the bonds collapse in price or become insolvent, the bonds become impaired assets and begin to affect their claims paying ability. This is why I believe the next area of concern will fall squarely in the asset management firms and insurance companies.

And let’s not forget hedge funds that despite being hedged are getting hammered as well. As markets begin to freeze up and nearly everyone is forced to de-lever simultaneously, we find asset prices falling yet further. Again, all of this is highly deflationary and is global in nature.

This is specifically why we avoid leverage for the most part as it is no fun to have a margin clerk tap you on the shoulder and tell you to sell something you would rather not sell. This is now occurring and it will not stop until the Fed, Treasury, ECB and other entities stop intruding and intervening in our markets. I, for one, am tired of the constant intrusion into what used to be a free market. I am tired of having Sunday’s become a work day and wait to see who will be merged into whom. Making it illegal for me to express my views about a bank or insurance company via a short sale is Socialistic and will simply make the pain last longer. Handing $700 billion of our money over to a bunch of fiscally irresponsible financial institutions is sickening. I have spent the better part of the last 10 years trying to understand the most complicated financial mess ever created and what happens? I end up the proud owner of all of the garbage I stayed clear of, namely Fannie/Freddie/AIG and $700 billion of nuclear waste. And then I get to watch the long list of executives at these institutions rewards themselves with tens of millions of dollars. What a country!

Who else is a seller of our paper? Foreigners. Each month, we are told how many assets are being purchased or sold by foreign institutions, mainly Foreign Central Banks. As I stated earlier, this is not just a problem in the US, it is global in nature. So they need to sell as well.

Below you will find three charts that show the 3, 6, and 12 month trailing cumulative totals of foreigners in equities, Treasuries and Corporates. The trends are rather obvious. The risk aversion trade is on, so now not only do we have forced domestic sellers, we have company in foreign institutions.

3 Month Trailing Cumulative Foreign Purchases


6 Month Trailing Cumulative Foreign Purchases

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How else do we know that deflation is upon us? There is considerable shrinkage in the commercial paper markets as demand for short term credit dries up. And it is drying up in a hurry. This is also highly deflationary.