Morning in Arizona

Morning in Arizona
Rainbows over Canyonlands - Dave Stoker

The Headline Animator

Wednesday, August 01, 2012

Investing through the summer fog of 2012

The economy continued to throw off mixed signals for the month of July, whipsawing traders and making investors even more squeamish and paranoid about where to tuck their wealth.

Added to this seesaw of economic data from everything from July's consumer confidence of 65.9, up from a revised 62.7; the July Chicago PMI of 53.7 up from 52.9.

The May S&P Case-Shiller HPI 20-city M/M rose 0.9%, however, the Yr/Yr fell 0.7%. The June New Home Sales figure fell to 350k from a revised up 382,000. The M/M Pending Home Sales Index for June dropped -1.4% from a revised downward 5.4% increase.

The Richmond Fed Manufacturing Index for July fell from -3 to -17. Conversely, the Empire State Manufacturing Survey, Kansas City Fed Manufacturing Index, Philadelphia Fed Survey all improved from the previous month.

The Dallas Fed Manufacturing Survey, consisting of a Business Activity Index and Production Index, found both indexes falling.

The knowledge that short-term markets are driven first by news headlines and central bank policies rather than primarily macro and macroeconomic data forces a perverse reaction onto the market in this unfamiliar climate we find our capital in.

Deteriorating economic statistics brings hope, by some, of additional stimulus measures from the Feds. Today, August 1, the Feds may shed some light onto their contingency plans, if there are any plans, for supporting a decaying economy between now and the November elections.

If Quantitative Easing III (QE III) or some variation of yield repression doesn't materialize from the Feds, markets will have an excuse to move lower, decaying as well.

Secondly, European Central Bank President, Mario Draghi, kicked off last Thursday's stock market rally by stating that he will do whatever it takes to save the Euro. A quick recap; in theory, generally, saving the Euro and the EU requires capping rising Spanish and Italian debt yields by the ECB agreeing to purchase their sovereign debt.

Because of inflationary fears, many German politicians, including Chancellor Angela Merkel's coalition government, vigorously oppose this action and similar bailout schemes. Two days ago, Monday, Treasury Secretary Timothy Geithner met with German Finance Minister Wolfgang Schaeuble and Mario Draghi, reaffirming their commitment in solving this crisis.

On Thursday, the European Central Bank will hold another policy meeting to find common ground. If the meeting fails to produce the proper response in the eyes of the market, this too will reverse last week's rally and send the market lower.

A third item that will send stocks lower in August, extending the S&P 500 incarceration in the current trading range between 1,099 and 1,419, if the realization sinks in of the draconian effects of federal budget automatic sequestration.

When austerity begins appearing in budgeting decisions in government, and workers begin preparing for possible layoffs and downsizing by reducing personal spending, and when businesses relying on government contracts to purchase their goods and services recalculate their cash flow and revenue, GDP will decline.

The May 2012, G.19 Federal Reserve Statistical Release, dated July 9th, shows "consumer credit increased at an annual rate of 8 percent in May. Revolving credit increased at an annual rate of 11-1/4 percent, while non-revolving credit increased at an annual rate of 6-1/2 percent." It's hard to imagine this type of credit activity continuing in the third and fourth quarters of 2012.

Our anemic economy grew 1.5% in the second quarter, down from 2.0% in the first quarter, with major help from consumer credit. Subtracting significant credit in the third and fourth quarters will exacerbate any weakness.

Individual savings rates were reported up 4.3%, annualized, in the first three months of this year, starving an already malnourished economy of vital disposable income. The minuscule interest currently being paid on savings is also problematic for an economy in need of greater money supply velocity.

An economically weakened Europe and a weakening China will inadvertently push the US economy over the edge unless smaller emerging markets can somehow re-accelerate the global economy while avoiding the developed nations' debt contagion.

The final culprit with the motive and opportunity to assassinate the economy is stagflation. As 2012 futures' prices on corn, oats, soy beans, and wheat reached multiyear highs, 1,300 counties spread over 29 Midwest states have been declared natural disaster areas by the USDA.

In the 1970's, President Richard M. Nixon imposed wage and price controls in an attempt to snuff out stagflation and inflation. President Gerald Ford attempted to talk down inflation with a Whip Inflation Now (WIN) campaign, complete with WIN buttons. Inflation ran rampant throughout the 1970's until a new Sheriff rode into town in 1979.

The newly appointed Federal Reserve Board Chairman, "Tall" Paul Volcker, ended inflation by jacking up short-term interest rates to 22%. Although, lifting interest rates to nosebleed levels induced at the time the deepest recession since the Great Depression, inflation did not return.

Another smart decision made by the government at the time was issuing callable long-dated treasury bonds and zero coupon bonds to minimize interest expense. This morning, Treasury announced it is investigating issuing floating rate notes; while interest rates are lower than they have been in the past 100 years. I'm puzzled by such a decision.

This earnings' season, restaurants such as McDonalds (MCD), Chipotle (CMG), Buffalo Wild Wings (BWLD), have admitted to struggles with cost inputs, missing earnings estimates, and are now lowering guidance for upcoming quarters. Food suppliers like Hormel Foods Corporation (HRL), Tyson Foods, Inc. (TSN), and Smithfield Foods, Inc. (SFD) are experiencing these headwinds, as well.

Brent Crude oil is priced north of $100 dollars a barrel. Members of OPEC require the price of oil to stay north on $80 dollars a barrel to maintain political stability at home. That price level is in conflict with jump-starting the global economy that is continuing to deleverage from the previous decade.

Regardless, if the price of oil should rise or fall short-term, the global economy will be petroleum-based for decades to come. Therefore, an essential building block for any inflation defensive portfolio requires an integrated oil company such as Exxon Mobile (XOM) or Chevron (CVX).

One final thought; although, we have experienced deflation in many things since 2008, technology, of course, real estate and virtually any asset requiring financing, and the cost of capital itself, this economic period will end, too. And once more, we will again face and fight inflation.

Unappreciated is the two-stage intermediate step between deflation and inflation – stagflation. Ben Bernanke has spent years and trillions of dollars attempting to re-inflate asset prices. One day he will succeed. At that point, Stage One, the rising cost of living, or cost-push inflation kicks in, whereby, too few dollars are available for rising prices.

Stage two of the stagflation equation is flat wages and personal income. Whether one draws a paycheck from a job or clip coupons from investments, purchasing power begins contracting, not growing.

This reality of less disposable income relative to prices, combined with an aging population and extended life expectancy is a recipe for structural economic arrested development until we surrender to full-blown inflation in future years.

Politicians will feel obligated to rectify the former condition and then, the more radical and dangerous phase of inflation occurs, demand-pull, leading to too many cheapened dollars chasing too few goods.

Confidence or the lack thereof, in a nation's currency, is the thin line straddling inflation and hyperinflation.

And, it is here, that your portfolio of hard assets such as gold and silver, agricultural commodities providing food security, natural resources such as land, timber, water, energy, selective adjustable rate debt, and very selective stocks, will pay off for the patient, long-term, investor during inflationary times.

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