Daily Investment Interpretations

October 17, 2010


2010-10-17 (Sunday Night):  Although I worked yesterday on Friday night's comments, I wasn't able to complete the story.
    Will oil's rise destroy demand?  Nick Godt reminds us that oil prices are rising because of a falling dollar and not because of anticipated demand for oil. In other words, rising oil prices aren't rising because of an anticipated recovery. Also, he raises the question again regarding whether the Fed's "QEII" will be effective.

"Gluskin Sheff chief economist Dave Rosenberg notes that $84 a barrel means higher gasoline prices ahead, while at the same time food prices are also rising. This would explain why supermarket chain Safeway /quotes/comstock/13*!swy/quotes/nls/swy (SWY 21.76, +0.10, +0.46%)  this week said it saw its problems with deflation easing as prices for consumers increased. (I find this interesting because, apparently, Safeway's rising food prices don't signal an end to the recession but arise because the Fed's new round of money printing is lowering the dollar, raising the prices of food and energy.)

"But unlike the last commodity boom of 2007, the unemployment rate is currently at 9.6%, not under 5%, Rosenberg notes.

"While higher food and gasoline prices are most likely not what the Fed wants to see, it might be good to remember that itís likely there will soon be some reprieve in early November, when the Fed is believed to actually announce new quantitative measures.

"Many say that the measures have already been priced in by the market, that the dollar is therefore due for a bounce, while stocks and commodities are due for a pullback or even a correction.

"But in the longer-run, the problem is likely to return, especially if the effectiveness of quantitative measures remain elusive, while the impact on the dollar and commodities is clear to all."

    It's time to stand back and take a long-term look at what's been happening in 2009 and 2010.
    By the end of January, 2009, before President Obama had even taken office, Paul Krugman predicted what was going to happen that year and this year. President Obama's fiscal stimulus plan was about ⅓rd what it needed to be to fill the GDP "output gap". 
    All the president's men predicted that, thanks to the fiscal stimulus package, the unemployment rate would top out at around 8% and then start to fall, and that U. S. GDP would rise around 3% in 2010.
    The markets bottomed on March 6th, 2009, but investment advisors, including Paul Krugman and Todd Harrison, were uniformly bearish until early May, 2009 (and in Todd Harrison's case, beyond early May, 2009). By that time, the markets had risen more than 30% off their March lows in two months, and were about halfway up to their April, 2010, highs. In a normal recession, I might have taken a chance and ridden the markets back up from their March lows, but this was the first recession since the great Depression which hadn't been induced by, and controlled by the Fed. But the Fed had fired its last conventional bullet (0% interest rates) and it hadn't even phased the bear. Were we headed for Great Depression II? I began buying in April, 2009, but only very diffidently.
    The stimulus began to be felt in the middle of 2009. The markets climbed until the end of April, 2010.
In late April, 2010, the markets began retract. In mid-May, they entered into a trading range that lasted until mid-September. Concurrent with this was the realization that Paul Krugman was right: the stimulus was too small, and it was running out, and the Republicans were claiming that fiscal stimulus hadn't worked. Per Paul Krugman's predictions, it became politically impossible for President Obama to effect a second round of fiscal stimulus. A continuing theme has been that runaway, Weimar-Republic inflation is about to occur at any time now, because of all the money the Fed is printing, and that foreigners will quit buying U. S. Treasury bonds, and then where will we be?
    Meanwhile, interest rates on U. S. Treasury bonds keep falling, and hitting new lows.
    Over the summer, worries about unemployment, European sovereign debt, a slowdown in the U. S.' recovery, and worries about a double-dip recession, kept a lid on the markets. The Federal Reserve reiterated its mantra that the recovery was on track, and that U. S. GDP growth would be in the 3% range for the year. It also became apparent that if any additional economic stimulus were needed, it would be up to the Fed to provide it.
In the meantime, U. S. industry continued to show improving profits and productivity improvements1. The sticking point in the U. S. economy was the persistent (and slowly rising) total unemployment rate, and the slow, steady decline in the core inflation rate... reminiscent of Japan's "Lost Decade" (lost two decades, by this point.)
    Dr. Krugman recommended that the Fed start buying Treasury bonds, and set a target rate of inflation to ward off deflation.
    The Fed has just now taken both these steps, vindicating Paul Krugman's position.
    The real flies in the ointment are:
(1) How much will the Fed's policies do to eventually lower the rate of unemployment in the U. S., and
(2) What will the Republicans do if they roll over the Democrats in the upcoming elections?
    Paul Krugman points out today that, as of this time, the core rate of inflation is still falling.

1 - A portion of U. S. stimulus money found its way overseas as U. S. buyers purchased goods and services abroad. Since the GDP's of East Asian countries are a a fraction of that of the U. S., this injection of cash may have a disproportionately stimulating effect on East Asian economies.U. S. corporations, in turn, have prospered through sale of U. S. goods and services in East Asia.
    Economists remain bullish on Fed asset buys  
    Stock market futures are down 0.5% tonight, and my investment advisory service is warning of a possible "sell" signal.