Tower Private Advisors
- Inflation protection, II
Capital Markets Recap
Gee, has anything happened this week?
There are a couple of angles to this story.
- First, is the economic angle. Energy prices are often considered a tax on consumers, something anyone who has filled up a petrol tank has experienced. So disposable income is reduced, leaving less to be spent on discretionary items. BCA Research estimates that every $10/barrel rise in crude oil reduces GDP by 0.1-0.2%. So this week’s increase in oil of $10.84 might shave that amount off of GDP. That wouldn’t represent a significant hit, but let the Suez Canal be blocked and let the nutjob Ghadafi blow up some of his pipelines–as he has threatened to do–and BINGO! oil is at $150. That’s another 0.5-1.0% off an economy that is growing rather slowly–2.6% in the fourth quarter, as indicated below.
- The second angle is the effect on capital markets and risk assets around the world. If events in the Mideast and North Africa take on a more insidious tone, say Libya confiscates oil production assets of a company like Marathon or a revolt in an ostensibly U.S.-friendly nation like Egypt, we could see a more general flight from risky assets like stock into bonds and precious metals.
We’ll be watching a couple of things in the week ahead to give us guidance as what might be yet to come. We want to see oil prices stay reasonable, and we’d not like to see them rise in concert with a rise in interest rates. That would leave us set up as were at market peaks in 1987, 1990, 2000, and 2007. For now, we’ve not made any drastic changes, even putting a little bit of money into stocks we’ve been watching for a pullback.
Inflation, part II
In the last Weekly Recap of two weeks ago, I reviewed the first part of an Alliance Bernstein report titled Deflating Inflation. That first part focused on the the effectiveness and reliability of various inflation hedges. It showed that while commodities and precious metals provided the best overall performance in times of high inflation, they weren’t equally reliable; some times they fared well; other times, not so well. I promised to cover the how-much and when angles next.
The chart below sums up the how-much question pretty well. Essentially, you need more inflation protection if:
- Your liabilities are sensitive to inflation
- Your capital is not considerably above what is needed to support your spending needs
- Your risk tolerance is low
The when question is more difficult. The article cites a Federal Reserve study that shows the range of inflation estimates among economists is wider than at any time since the 1980s. So even the wise guys who have all the fancy models don’t agree on where inflation is going. It’s extraordinarily difficult to predict when inflation will flare up. The whole government-printing-money thing is no sure bet that inflation is coming so long as the money printed stays out of circulation and in bank vaults. Japan ramped up its money printing in the early 1990s. There was no demand for the funds (i.e. no borrowing) so the money didn’t find its way into the economy. The result was two decades of deflation. In contrast, in the U.S. in the ’70s, the government printed money, and there was a huge demand for it. The result was very high inflation. As a rule, the money supply should grow at about the growth rate of the economy.
The article suggests watching three key items:
- Money and credit growth – they rate this as a low-medium risk presently
- Wage growth – rated as very low
- Aggregate demand & supply – also very low.
The article ends by saying that inflation protection is like insurance: you buy it before the house is on fire, and, “now is as good a time as any to buy inflation protection.”
There were a whole host of economic releases this week, but I’ve decided to focus on just four here. Initial Jobless Claims fell again this week, making for the third of the four below 400,000. Revisions continue to be upward, however, and that remains troubling. We should see most of the revisions going downward, not the other way round. Still, we’re at pre-Lehman crisis levels. Housing still seems to be going nowhere, with New Home Sales falling by (-)12.6% and Existing Home Sales rising by just 2.6%. The second coming of Q4 2010 Gross Domestic Product was released today. While we are two months past the end of the quarter, enough data has come in since the first release at the end of January that the data have changed. From 3.2%, GDP was revised down to 2.8%, well below the expectation for a slight increase to 3.3%. Don’t tell that to the folks surveyed by the University of Michigan in its twice-month Consumer Confidence survey. Those folks reflected an optimism not seen since the beginning of 2008.
Key indicators to watch . . . there’s really just one, the last one below
- Personal income, spending, and saving (Monday) – January
- ISM Manufacturing (Tuesday) – February
- Federal Reserve Beige Book (Wednesday)
- ADP Employment Situation report (Wednesday) – February
- Initial Jobless Claims (Thursday) – weekly
- Nonfarm Payrolls (Friday) – February
- Unemployment Rate (Friday) – February
- Chicago Purchasing Managers (Monday) – February
- NAPM – Milwaukee (Monday) – February
- Dallas Fed Manufacturing Activity (Monday) – February