Stagflation: Stock markets & inflation - III
Summary
Today we add numerous macro as well as commodity recommendations to our list. We also tell you why we are withdrawing some previous recommendations. Subscribers, see Part 3 of today's missive.
On a recent Bloomberg screen we read:
"May 16 (Bloomberg) -- The world's most powerful central banks are telegraphing the end of interest-rate cuts, and traders already anticipate the first steps in the opposite direction.
Federal Reserve officials this week flagged inflation risks after slashing borrowing costs seven times since September and Bank of England Governor Mervyn King unveiled Britain's worst price outlook in a decade. Faster growth is vindicating European Central Bank President Jean-Claude Trichet's refusal to cut rates in response to the credit crisis...
The danger is that food and oil prices are rising so fast that inflation will replace costlier credit as the chief threat to the global economy. That may force the Fed to turn a deaf ear to what King labels the ``siren'' calls for rate cuts and perhaps consider raising them instead.
Fed Chairman Ben S. Bernanke, 54, and his team reduced their benchmark rate by 3.25 percentage points to 2 percent. The Bank of England has cut its main rate three times to 5 percent and Canada's central bank has moved on four occasions to 3 percent...
Some traders are increasing their bets the Fed will reverse recent cuts later this year. Fed funds futures traded at the Chicago Board of Trade signal a 22 percent probability the Fed will raise its main rate to 2.25 percent by the Sept. 16 policy meeting, compared with 7 percent a week ago....
Former Fed Chairman Paul Volcker warned on May 14 that ``there is some resemblance to where we are now in the inflation picture to the early 1970s,'' when central banks failed to contain a pickup in prices..."
So how do you make money off this seeming sea-change in sentiment? Before you do that, we have spent hours in a neon cage calculating pattern predictions with you, as in: "what happened last time?" More investment recommendations follow over the next couple of days, probably from Hong Kong.
Topics Covered
- Stock markets & inflation
- Why commodities?
- How to make money off these ideas
Background
1. Stock markets & inflation
We belong the the group that gives far more credit to Paul Volcker than to Alan Greenspan. My view is that the latter gentleman created such an excess supply of money, particularly after 9/11, that today's inflation or excess demand for goods in the parlance of The Economic Clock™ is the logical result.
Note that we refer to "excess demand for goods" and yet have been blathering on about "cost push" inflation. How do we reconcile these seeming contradictions? Emerging markets. See below for more, please.
We humbly would add to Mr. Volcker's remarks above that there actually have been four rounds of commodity-driven inflation, the head lights that we all are blinking at yet again. Let's see when they were and what happened to the U.S. stock market:
| CPI Trough | CPI Peak | CPI Trough | |
| ROUND ONE | 10/67 | 2/70 | 8/72 |
| CPI, YOY% | 2.5% | 6.3% | 2.9% |
NYSE % gain, from CPI trough | 18% (peaked 11/68) | ||
| NYSE Trough | 6/70 | ||
NYSE % tumble, peak to trough (11/68-6/70): -31% | |||
| | |||
| ROUND TWO | 8/72 | 12/74 | 12/74 |
| CPI, YOY% | 2.9% | 12.4% | 4.8% |
NYSE % gain, from CPI trough | +6% (peaked 12/72) | ||
| NYSE Trough | 9/74 | ||
NYSE tumble, peak to trough (12/72 - 9/74): -48% | |||
| ROUND THREE | 12/76 | 4/80 | 8/83 |
| CPI,YOY% | 4.8% | 14.7% | 2.6% |
NYSE % gain, from CPI trough | +36% (peaked 3/81) | ||
| NYSE Trough | 7/82 | ||
NYSE tumble, peak to trough (3/81 - 7/82)): -21% | |||
| ROUND FOUR | 12/86 | 11/90 | 5/94 |
| CPI, YOY% | 1.1% | 6.3% | 2.3% |
NYSE % gain, from CPI trough | +43% (peaked 5/90) | ||
| NYSE Trough | 10/90 | ||
NYSE tumble, from peak to trough (5 - 10/90): -15% | |||
| NOW | 10/06 | 7/09 - 6/10 | 4/12 - 3/13 |
| CPI, YOY% | 1.3% | 5.1%-6.5% (3.9% at4/08) | |
NYSE% gain, since CPI trough | +6% |
That a lotta table to chew through! Let me be your sherpa.
- In the first of each "Round", we give you the annual percentage changes of America's consumer price inflation
- In the second line, we calculate how much the market (the New York Stock Exchange, or NYSE) rose from when inflation was at rock bottom (the column, "CPI Trough") to when the market itself peaked.
- In the third line, we reveal when the stock market bottomed,
- Finally, we suggest how much the market fell from its peak to its trough.
Where I have gone wrongly is to be short of the market. This exercise proves suggests that the stock market has risen during the up-leg of inflation, on the whole has bottomed when inflation has peaked. Per the final set called "NOW", note that the stock market's up leg is still pretty weak, showing a gain of a mere 6% since inflation bottomed in October 2006; furthermore, this analysis suggests that inflation will peak in a good year, at the earliest.
For us investors, the following conclusions may be useful pattern predictions. I asked what happens to stock markets once inflation starts rising.Thus, we measure stock market behaviour from the bottom of the inflation cycle, i.e. from 10/67, 8/72,12/76 and 12/86, these being the four "Rounds" in the preceding table.
| Stock Market Rises | Stock Market Rises | Stock Market Falls | Stock Market Falls | |
Up months from inflation trough | % gain from inflation trough | Down months from market peak | % drop from market peak peak | |
Average
| 26 months | 24% | 14 months | -20% |
Standard Deviation | +/- 22 months | +/- 17% | +/- 7 months | +/- 14% |
This time around, inflation bottomed in America at an annual rate of 1.3% in 10/06. Using the above averages, here is our pattern prediction for the U.S. stock market:
- rise for just over two years, say to October 2008
- rise by about 24%
2. Why commodities?
In the first part of part one, we referred to cost-push inflation being the "fault" of emerging markets. We all know that, next to deliberate supply constraints, commodities are in huge demand particularly by industrializing countries like China and India. No hidden secrets here!
Crucially, Chindias' governments have political mandates to create jobs - otherwise, the respective rulers will be out of jobs themselves. That assignment means that Beijing has to create 10 million new jobs a year.
So what do people with higher incomes do? As anywhere, their expectations rise, so they spend more. They eat better food, and replace animals and legs with vehicles...
All of which means that the commodity boom that we are seeing is here to stay: Chinda's political mandate to improve living standards has to intensify...
Thus, demand for metals and minerals will rise, just as it will the demand for improved dining,as we pointed out last Sunday.
More tomorrow. Signing off for now. My brain has burned into fried rice in this neon cage in Phuket! Apologies.
3. How to Save/Make Money Off This Idea
- Always consult your financial adviser first.
- We advise strongly reducing your positions in the following currency ETFs, the logic being that if U.S. rates have bottomed, markets will start looking at the dollar looking more attractive on account of its cheapness and the prospect of higher dollar interest rates. Because we are commodity fans we are keeping the Australian dollar, but are reducing our holdings of:
- Euros: Bloomberg code FXE:US
- Yen: Bloomberg code: FXY:US
ADDITIONAL RECOMMENDATIONS OF 19TH MAY 2008
- We are withdrawing all ETF "shorts":
- The short on the U.S. S&P 500, SDS:US (following the above pattern prediction, we will climb back in around September);
- The short on U.S. financials, SKF:US (not our investment skill set)< and
- The short on Japanese financials, EWV:US (not our investment skill set)
- We are adding the following macro ETFs because The Economic Time™ is fine in each economy:
- Brazil, EWZ:US (also: she is a major commodities producer);
- Russia, RSX:US (also: she is a major commodities producer), and
- Taiwan, EWT:US (we like the pro-business government that just got elected)
- We also like the following commodity plays:
- BHP Billiton, BHP:AU (a well-run global explorer and producer of minerals);
- Noble Group, NOBL:SP (a leading, well-run supplier of supply chain management services for agricultural and non-agricultural commodities);
- Cnooc, 883:HK (China's sole onshore oil producer), and
- Bumi Resources, BUMI:IJ (an Indonesian coal miner whose profit over the next two and a half years, according to The Economist of 3rd May 2008, should equate to a third of its $14 billion stock market capitalisation.)
