Keeping An Eye Out: Mid April 2011

In an effort to keep tabs on my thesis and whether reality is matching my forecast, I periodically review my outlooks and compare them to recent news/events.  Please click (here) for my latest outlook for comparison purposes.

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–> Inflation:  Warnings regarding inflation are looming in the US and they would be cause for concern regarding my thesis on inflation.  Consumer inflation expectations have also been on the rise as well.  Both these factors scream inflation is coming.  However, wage growth clearly remains anemic and credit growth non-existent (revolving credit continues to fall).  Growth in spending power is very weak and is NOT keeping up with recent inflation in oil and raw materials (food) — ie Real Wages are declining.  All this taken together points to major margin squeezes for companies that are unable to adequately pass these costs to consumers.  This dynamic can clearly be seen in differences between the recent PPI and CPI reports.  As I covered in my outlook, inflation is indeed present in raw materials, but all this does is sap purchasing power from discretionary items.  Think 2008 all over again (look at the dates in these articles).  Oil was racing up to $150 and inflationary fears were a-la-mode.  What happened shortly thereafter?  A deflationary shock as consumers were unable to cope with higher commodity prices along with a deflating housing market (which we have now as well!).  Related to this outlook, I am reaffirming my bullish call on Treasuries, I would be accumulating at these levels.  

–> Gov’t Outlook:  Republicans and the Tea Party are demanding that the US debt crisis be put front and centerMy Government outlook remains firmly on track when I see articles like this and this.  What I’m thinking about now: How would policymakers react if we had a decline in economic activity?  Would they stay the austerity course, or would they cave quickly and initiate more stimulus?  I’m thinking it would be very difficult to flip the switch and return to the fiscal largess of the past.  Politicians from both parties would look ridiculous and none of them want to look that way after investing political rhetoric in “doing the right thing for our country”.  The Recognition Delay may be very long and that poses a big risk.

–> Global Economy: Overall, we are seeing mixed news and the outlook remains very clouded, but with a positive hue.   My thesis calls for more bad news ahead on the whole.

First, the good news:

  1. The AUD/USD has hit new highs and shows that demand in Australia (a good proxy for China) remains strong.
  2. China just reported trade numbers, which show that the country’s export sector  continues to hum along despite the earthquake and recent rate increases.  This opens the door to Yuan appreciation as an additional tool to fight inflation, taking some of the pressure off of interest rate increases.  My thesis states that exporters won’t be able to take on a substantial increase in value of the Yuan.  Perhaps these trade numbers show otherwise.
  3. The Eurozone seems to be sorting through its issues.   Italian and Spanish bond 10-yr yields are slowly separating themselves from the PIIGS.  If they keep falling, then the Euro crisis should remain contained.  I see the Eurozone as the weakest link in the global recovery so far.

Now the bad:

  1. While the market may be signaling that conditions are improving in Euroland, political issues related to the bailout and austerity packages continue to fester.  Talks of debt restructuring for Greece are gaining momentum as the country seems to be in a debt trap.  If investors begin feeling that losses won’t be guaranteed, the Eurozone crisis may flare up once again.  If Portugal and Ireland see that Greece is getting a pass, why not them?  Why would they have to put up with austerity when the Greeks were forgiven?  Political will for shielding imprudent investors at the expense of regular citizens (taxpayers) is weakening in various countries.
  2. China continues to raise rates to cool down its economy as I had forecast.  The Shanghai and Hang Seng indices haven’t made new highs since July 2009 and November 2010 respectively.  It also seems likely that they will raise rates further as an inflationary environment continues to dominate.  Policies enacted by officials to cool the red hot real estate market are finally beginning to have an effect (some ugly news regarding property prices recently caught my attention).  I agree with Soros that China might be losing control of the inflation situation.  
  3. Copper is not confirming the AUD/USD breakout.  Keep an eye on the economic doctor.

–> Consumer Confidence: I’ve nailed this outlook for sure.  As expected, consumer confidence has been slowly rising only to have it knocked back down due to higher oil/food prices.

–> US Dollar/Monetary Policy:  Recent news shows a less opaque path for monetary policy.  More Fed presidents are announcing that the coast is clear (all 3 are voting members of the FOMC).  Ben himself said on March 1st that the “risk of deflation has become negligible”.  Some are even blaming the Fed for recent spikes in commodity prices.  It’s not all one-sided though.  We still have Fed doves claiming that inflationary pressures are transitory, or they aren’t the Fed’s fault.  I am more certain that QE2 will not be immediately followed by QE3 and is in-line with my thesis.  What’s important in my view as well is what’s going on around the world.  The Eurozone remains unstable and China’s outlook is becoming more uncertain by the day.  Finally, let’s not forget about rising oil prices.  Exogenous shocks that could tilt the US back into recession abound.  Regarding this outlook, while the dollar (Symbol: DXY) has fallen roughly 3% since I turned bullish in late October, I would continue to accumulate at these levels.  If however the DXY falls below $71.00 then I would close my position (and recommendation) and live to fight another day.

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Near the end of the month, I’ll cover: Manufacturing, Service Industry, Housing, Jobs, and Consumption.

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