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Today's WrapUp by Mike Hartman 01.14.2004 Mon Tue Wed Thu Fri Archive |
Rhetoric versus Reality
With all of the conflicting rhetoric coming from the U.S. Treasury, the Federal Reserve, European Union and the European Central Bank, there is good reason to be confused about the near term direction for stock and bond prices, not to mention currency exchange rates. Stocks opened higher today, with government bonds neutral to slightly lower. By mid-day Treasuries moved into positive territory with the NASDAQ Composite falling back to where it opened. As I write, both stocks and bonds are higher for today’s session, along with the U.S. dollar. The dollar strength can be attributed to the comments from E.C.B. Council Member Christian Moyer who stated that, “Intervention is something that’s always available.” The European officials are essentially talking the euro down without taking any real action yet. Market participants are trying to decipher the messages from government officials and central bankers from both sides of the pond. It is most unusual to see stocks, bonds and commodities all moving higher at the same time.
Yesterday Richard Russell put it this way, “I want to say a few words about bonds. Today, the March 30-year T-bond broke out above three preceding tops to its highest level since last July. Doesn’t that seem counter-intuitive? Commodities going up, precious metals going up, copper going up, oil going up, stock market going up – and bonds also going up? What gives? It’s a real mystery. The only thing I can think of is that a certain group of investors believe that either inflation will simmer down or that there’ll be some actual deflation. At any rate, the yield on the long bond has broken below 5%, a very unexpected development.”
With the massive stimulus that has come from increased government spending, artificially low interest rates, and the extraction of home equity, I can understand the stock market moving higher and commodities moving higher which implies inflation. That being the case, bond prices should be moving lower with the corresponding rise in interest rates to offset inflationary expectations. So far that is not happening. I believe bonds are not breaking lower because of the artificial demand coming from Japan. As Japan intervenes in the currency market, they are selling yen to buy dollars, which are then used to buy U.S. Treasury debt. For the time being they have put a floor on bond prices, but how long will this artificial demand continue? I believe the secondary cause of artificially low interest rates is the Federal Reserve endorsed bond carry trade. As long as the Federal Reserve PROMISES to keep the Fed Funds Rate at 1%, they have removed the risk for institutional investors that borrow money at 1% and invest in longer dated bonds that are yielding 4% to 5%. This is a huge set-up for a big fall somewhere down the road. Take away the foreign demand and force institutional investors to unwind their carry trade, and bond prices could drop dramatically as they did last summer.
Also, go back to late 2001 when Federal Reserve officials were concerned about the real threat of deflation. At the time they said they would monetize government bonds should it become necessary (basically means to create new money to buy our old debt off the market). From that point bond prices shot higher until they peaked in June 2002. In the following three months bonds were crushed for 10% when Mr. Greenspan said that it would not be necessary for the Feds to buy bonds. They are now essentially doing what they said wouldn’t be necessary, the difference is they are using foreigners, primarily Japan, to support the dollar and help keep a lid on interest rates.
More Confusing Rhetoric
The one that probably bothers me the most is this so-called “strong dollar policy.” When President Clinton embarked on the strong dollar policy back in 1995 the US Dollar Index stood at 82. Roughly six years later it topped out at 125, went sideways for a year, and in just the last two years it has fallen about 30% to just about where it began in 1995. The U.S. dollar has been hammered over the last two years and on Monday we heard from Robert Nichols, a Treasury Department spokesman. According to Reuters, Mr. Nichols was asked why the dollar’s value had continued to erode and his answer was, “There’s no change in our strong dollar policy.” To me his answer really sounds like this: The sky is green! No, it’s blue. As I said, the sky is green. The sky is green because I say it is green.
According to a Bloomberg article yesterday, “U.S. Treasury Secretary John Snow didn’t mention the dollar in a speech to the U.S. Chamber of Commerce last week. In remarks to reporters later, Snow reiterated support for a “strong” dollar and foreign exchange rates set by markets.” When I think of the markets setting rates, it would imply that the market is free from government intervention. We all know that is the furthest thing from the truth for what is happening today. Japan openly flaunts their intervention in the foreign exchange market and yesterday I read an article saying Brazil is now competing in the currency devaluation game. Brazil’s currency fell from an 18 month high after the central bank sold the real to weaken their currency and support the dollar. The strong dollar policy could sure use some explanation from our officials and with all the intervention in the currency market, it does not appear the market is setting exchange rates.
There is No Inflation!
The constant mantra from our officials at the Federal Reserve goes something like this: We can keep interest rates at forty-year lows because there is no inflation. I read it as follows: The economic recovery will be in jeopardy if interest rates rise and second, they are sending the message to the European Union that everyone must participate in re-inflating the global monetary system. If the Europeans decide to devalue the euro like most other countries are already doing with their respective currencies, all it will do is slow the decline of the dollar. If currency exchange rates move too quickly it will cause too many dislocations globally. This is why currency trends tend to remain in place for a sustained period of time, usually five to seven years. My best guess says they will have to intervene sometime in the very near future. In fact, they have already begun the process by talking the euro lower. If the euro is deliberately weakened relative to the U.S. dollar, it should be a positive for the stock market and definitely a positive for the dollar.
If all currencies devalue it will be highly inflationary. The U.S. dollar still needs to fall the most in order to correct our trade deficit and our federal budget deficit. Things we need and use will cost more in all currencies, not just more in dollars. They can expand the supply of all fiat currencies by 5%, 10% or 20%. I would sure like to see them expand the above ground inventories of gold and silver by 10%. It’s physically impossible! More fiat currencies and basically the same amount of precious metals means much higher gold and silver prices along with commodities. Prices are going to move higher for everything, it’s just not here yet.
The CBS MarketWatch headlines read, “U.S. producers paying more for inputs. PPI up 4% in 2003 on energy costs; core rate rises 1%.” The 4% rise in 2003 is the biggest calendar year increase for the Producer Price Index since 1990. While the increase of 1% doesn’t seem like much to the core rate, it is the fastest increase in over two years. But there is no inflation!
In 2003 finished energy prices rose 11.5% and finished food prices rose by 7.7%. Now you know why inflation statistics are usually stated “excluding food and energy.” They are probably the two biggest things we use every day. But there is no inflation!
Core crude goods prices (goods at the beginning of production or “inputs”), excluding food and energy jumped 3.4% in December. Gasoline prices went up 5.1% in December and overall energy prices rose 1.8% for an annualized rate of 21.6%. The Labor Department said the cost of fresh and dried vegetables jumped 20.7% in December. But there is no inflation!
Tomorrow we will get the most recent numbers for the Consumer Price Index. With creative accounting and hedonic indexing (statistical manipulation) I will just have to guess that, “There will be no inflation.”
In the Pipeline
Prices are moving higher, it just hasn’t made it to retail yet. We are still running our factories at 75.7% of capacity, meaning we have a huge amount of excess. Excess capacity also exists overseas. I have to believe the lack of pricing power at retail will lead to deterioration of corporate earnings moving forward. That will not bode well for the stock market and in fact we will probably see margins coming down with the holiday sales reports that are forthcoming. Mr. Paul McCulley of PIMCO (managing director of $100 billion) puts it this way, “You have cutthroat competition globally and here in the United States, and there’s no ability for producers to pass along increases in commodity prices.”
Inflation is in the pipeline, it’s just not here yet due to excess capacity and excess labor. How can wages go up commensurate with inflation when we have so many people out of work? The striking grocery workers are a perfect example. They couldn’t get a better wage and benefits package because there were lots of people waiting in line to take their jobs.
Back to Today’s Market Activity
As I said at the beginning, it is highly unusual to see stocks, bonds and commodities all going higher at the same time. Well, it happened again today along with the U.S. dollar getting stronger. I see this as hot money returning to the U.S. dollar with the uncertainties of the monetary response that will be forthcoming from Europe. If the euro gets too strong they will be forced to act. Money moved back into the U.S. dollar and bought both stocks and bonds today.
The Dow Jones Industrial Average jumped 111 points (1.07%) to close at 10,538, the NASDAQ Composite added 14 points (0.7%) to close at 2,111 and the S&P 500 added nearly 10 points (0.8%) for a close of 1,130. Treasury Bonds were also higher today with a 30-year bond closing at 112 15/32 a gain of 0.6% and the 10-year Treasury Note adding 0.15% to close at 114 19/32. In the big picture commodity prices have been moving higher, but not today. The grains were mixed with soybeans and wheat higher, beef prices rose roughly 2% as they recover from the mad cow scare, energies were mixed with crude oil and natural gas showing mild gains while heating oil cooled off a bit.
Commodity prices were overall lower today, but not by much. Only a few of the commodities moved more than 2% either way. What I found most interesting was the sell-off in the gold and silver mining stocks. Gold only dropped $2 or 0.5% with silver falling $0.16 or 2.4%, but most of the mining stocks were hit for 4% to 7%. The XAU Gold/Silver Index dropped 4.1% to 101.4 and the HUI Unhedged Gold Bugs Index fell 4.8% to close at 228.2. Gold and silver investors seem to be getting nervous for a big pull-back. My best guess says we will consolidate after the recent gains, especially in silver, but I do not expect the dramatic declines like we have seen in the last two years. Too much new money wants into the precious metals arena and there isn’t enough to go around. See where this short-term decline ends, and you will have an excellent entry point to take advantage of the next bull run in the metals. Hold your core positions and re-enter your trading positions when the time is right!
Have a Great Evening!
Mike
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