Tuesday, May 10, 2005
Oil Price & The Stock Market
The oil price broke above $35 per bl. in 4/04. This was the first time in over twenty years that oil moved above its inflation adjusted price, and marked the end of a lengthy period of "cheap oil". Since then, the stock market has been sensitive to the near term direction of the oil price, with investors sensing that expensive oil may have detrimental economic consequences. It now appears that the oil price needs to be added to the list of economic variables, such as interest rates, that must be factored into any analysis of the stock market. After all, like the cost of money, oil is a major capital input for business, and can have a significant effect on profits and capital budgets. So too, oil like interest rates, will affect consumer confidence and purchase decisions.With oil currently rebounding again, it needs to be taken into account in gauging the short term outlook for equities, as a rising oil price may inhibit the recent rally in stocks.
Monday, May 09, 2005
Short Term Interest Rates
Fed Funds Target Rate: 3.00%
The Fed is on track to have the Fed Funds rate at 4.00 - 4.25% by year end 2005. A growing number of observers now think the Fed may quit raising rates at either 3.25% or 3.50%, citing evidence of an economic slowdown.
The Fed undertakes to raise rates when: 1) economic growth is strong, 2) capacity utilization is on the rise, 3) inflation pressures are intensifying and 4) short term business credit demand is advancing at a faster clip than is monetary liquidity.
For now, only condition (1) is clearly suspect. Capacity utilization is still in an uptrend, credit demand is very strong (up 11% yr/yr) and inflation indicators have not settled down enough to warrant a clear call that the latest push up on inflation has ended.
Since the speculation about a an interim top in rates will continue, below are some benchmarks that might prove helpful in benchmarking the action:
A. The Fed would take notice if the ISM index for manufacturing purchase management was to dip below 50%. It is now in a downtrend, with the April reading at a moderately strong 53.3%.
B. The capacity utilization rate, which is trending up, begins to flatten out. Important here besides the growth of production is the growth of capacity itself, which is advancing at a very slow 1.2%.
C. The CRB Futures Index, now at 300.5, dips further and confirms a solid seasonal topping pattern. The CPI registers a couple of months of 0.2% or lower readings.
If it looks like the economy is clearly slowing and inflation pressures are abating, the Fed would likely wave off the sharp rise in credit demand, believing that it reflected financing of inventory accumulation with the latter being seen as unsustainable.
The Fed is on track to have the Fed Funds rate at 4.00 - 4.25% by year end 2005. A growing number of observers now think the Fed may quit raising rates at either 3.25% or 3.50%, citing evidence of an economic slowdown.
The Fed undertakes to raise rates when: 1) economic growth is strong, 2) capacity utilization is on the rise, 3) inflation pressures are intensifying and 4) short term business credit demand is advancing at a faster clip than is monetary liquidity.
For now, only condition (1) is clearly suspect. Capacity utilization is still in an uptrend, credit demand is very strong (up 11% yr/yr) and inflation indicators have not settled down enough to warrant a clear call that the latest push up on inflation has ended.
Since the speculation about a an interim top in rates will continue, below are some benchmarks that might prove helpful in benchmarking the action:
A. The Fed would take notice if the ISM index for manufacturing purchase management was to dip below 50%. It is now in a downtrend, with the April reading at a moderately strong 53.3%.
B. The capacity utilization rate, which is trending up, begins to flatten out. Important here besides the growth of production is the growth of capacity itself, which is advancing at a very slow 1.2%.
C. The CRB Futures Index, now at 300.5, dips further and confirms a solid seasonal topping pattern. The CPI registers a couple of months of 0.2% or lower readings.
If it looks like the economy is clearly slowing and inflation pressures are abating, the Fed would likely wave off the sharp rise in credit demand, believing that it reflected financing of inventory accumulation with the latter being seen as unsustainable.
Wednesday, May 04, 2005
Inflation Note
The US economy has been experiencing the strongest inflation impulse or impetus in nearly thirty years. Since mid-'02, the yr/yr CPI % has moved up from a low 1.1% to 3.2% through Q1 '05. The pressure reflects large increases in the prices of cyclically sensitive materials as well as energy. Operating rates in these areas have risen to high levels reflecting strong demand resulting from the economic recovery in the US as well as strong demand from Asian economies, with the latter now having a much larger economic base because of the rapid growth of China and India, particularly.
In addressing inflation pressure in 2005, the Federal Reserve has elected to continue a course of progressive but moderate tightening of the monetary reins. In essence, the Fed is betting that the recent run-up in the prices of oil and natural gas reflect very strong seasonal demand and that oil and gas prices will weaken signicantly as buyers realize there will be ample supplies in the months ahead. The Fed is also aware that with manufacturing and business-commercial sales having outpaced consumer spending and export demand for months, inventories are trending up sharply. The eventual re-balancing of business output relative to consumer demand is expected to result in slower overall economic growth and some price concessions.
If the Fed's judgment is correct, yr/yr CPI% could eventually slide from 3.2% to the 2.5 - 2.7 % range at some point over half 2 '05. It will be an interesting period, because this is the first time in a good several years that the economy faces an inventory overhang. Moreover, since operating rates for finished goods show continuing significant slack, inflation pressure could dissipate readily if the fuels and sensitive materials price composites exhibit weakness.
At present, inflation thrust measures are still too strong. Oil, recently $50-56 a barrel, would need to move down to $42-47 a barrel and stay there for several months if inflation is to decelerate as the Fed hopes. Likewise, The CRB Commodities Futures index would need to go to 285-290 area from the present 300 (While I fiddle with setting up links, you can go to stockcharts.com and pull up $WTIC, $CRB and $NATGAS to play with).
There is a longer term issue here. If the Fed's tightening gambit works, It will find that, as It moves to ease up on the reins down the road, inflation pressures will likely return.It may have to contend with new surges in fuels and sensitive materials prices, and in addition, end stage processing prices may firm faster because slack may be used up quickly.
In addressing inflation pressure in 2005, the Federal Reserve has elected to continue a course of progressive but moderate tightening of the monetary reins. In essence, the Fed is betting that the recent run-up in the prices of oil and natural gas reflect very strong seasonal demand and that oil and gas prices will weaken signicantly as buyers realize there will be ample supplies in the months ahead. The Fed is also aware that with manufacturing and business-commercial sales having outpaced consumer spending and export demand for months, inventories are trending up sharply. The eventual re-balancing of business output relative to consumer demand is expected to result in slower overall economic growth and some price concessions.
If the Fed's judgment is correct, yr/yr CPI% could eventually slide from 3.2% to the 2.5 - 2.7 % range at some point over half 2 '05. It will be an interesting period, because this is the first time in a good several years that the economy faces an inventory overhang. Moreover, since operating rates for finished goods show continuing significant slack, inflation pressure could dissipate readily if the fuels and sensitive materials price composites exhibit weakness.
At present, inflation thrust measures are still too strong. Oil, recently $50-56 a barrel, would need to move down to $42-47 a barrel and stay there for several months if inflation is to decelerate as the Fed hopes. Likewise, The CRB Commodities Futures index would need to go to 285-290 area from the present 300 (While I fiddle with setting up links, you can go to stockcharts.com and pull up $WTIC, $CRB and $NATGAS to play with).
There is a longer term issue here. If the Fed's tightening gambit works, It will find that, as It moves to ease up on the reins down the road, inflation pressures will likely return.It may have to contend with new surges in fuels and sensitive materials prices, and in addition, end stage processing prices may firm faster because slack may be used up quickly.
Friday, April 29, 2005
Stock Market -- More on Fundamentals
S&P 500: 1146
I gave up on investing in 1996, when the bubble first started to form. Now, nearly ten years later, the market is far more reasonably priced, but I am at an age where long term investing holds little allure. So, I will buy shares, hold for a while, then sell and pay my taxes.
From a business cycle perspective, the best time to own stocks is when interest rates are falling, monetary liquidity measures are accelerating in growth, confidence in the economy is on the rise and profits are recovering back up to the long term trend line. In this cycle, that all ended around 3 / '04. Since then, the key fundamentals have slowly deteriorated and went fully negative over the 2 / '05 - 3 / '05 period. I do not see us in the kind of squeeze that kills an economic expansion, but as going through a period designed to enforce an economic slowdown to remove some of the inflation pressures from the system. The Fed would strongly prefer to stretch this expansion out another four - five years if it can.
For my part, I intend to wait out this interval until inflation pressures abate and market short term interest rates begin to weaken a little. At that point, it would be a good time to see if aggressive exposure to the market is in order.
In the meantime, fundamentals can yield up the occasional trade. One measure I like is the direction of Federal Reserve Bank credit. http://www.federalreserve.gov/releases/h41/Current/
This account is down so far for the year, and if the Fed is to maintain a policy of moderate liquidity growth as I suspect, They will have to add nearly $60 billion to Their account by year end 2005. I expect the FOMC to begin stepping up purchase activity over the next 4-6 weeks. If the Fed wants to buy, may be I should too.
I gave up on investing in 1996, when the bubble first started to form. Now, nearly ten years later, the market is far more reasonably priced, but I am at an age where long term investing holds little allure. So, I will buy shares, hold for a while, then sell and pay my taxes.
From a business cycle perspective, the best time to own stocks is when interest rates are falling, monetary liquidity measures are accelerating in growth, confidence in the economy is on the rise and profits are recovering back up to the long term trend line. In this cycle, that all ended around 3 / '04. Since then, the key fundamentals have slowly deteriorated and went fully negative over the 2 / '05 - 3 / '05 period. I do not see us in the kind of squeeze that kills an economic expansion, but as going through a period designed to enforce an economic slowdown to remove some of the inflation pressures from the system. The Fed would strongly prefer to stretch this expansion out another four - five years if it can.
For my part, I intend to wait out this interval until inflation pressures abate and market short term interest rates begin to weaken a little. At that point, it would be a good time to see if aggressive exposure to the market is in order.
In the meantime, fundamentals can yield up the occasional trade. One measure I like is the direction of Federal Reserve Bank credit. http://www.federalreserve.gov/releases/h41/Current/
This account is down so far for the year, and if the Fed is to maintain a policy of moderate liquidity growth as I suspect, They will have to add nearly $60 billion to Their account by year end 2005. I expect the FOMC to begin stepping up purchase activity over the next 4-6 weeks. If the Fed wants to buy, may be I should too.
Saturday, April 23, 2005
Stock Market -- Fundamentals
S&P 500: 1152
I have us as remaining in a cyclical bull market in the USA. True
enough, the market is no higher than it was a year ago, and has
been in a correction phase recently. But the action of the market
is merely repeating what happens after the powerful initial phase
of stock price and profits recovery in the wake of recession. Once
profits complete a "V"pattern recovery and move into the expansion
phase, it is common for inflation pressures to intensify and for interest
rates to begin to rise. This is what we experienced over 1964-66,
1973, 1983 and 1994.
The process of inflation containment has grown easier over the years
for three reasons: 1) The Fed has learned to move more forcefully;
2) It has attacked inflation earlier in the cycle; and 3) accounting and
tax policies have made inventory speculation less attractive for
businesses. The Fed did fail to extend the expansion and the bull
market over 1973-74, as companies pursued aggressive inventory
speculation via FIFO accounting -- "first in, first out" -- which led to
large but unsustainable earnings gains, inventory imbalances and
recession.
The process of inflation containment to extend economic growth and
the bull market could be difficult this time. The current inflation impulse
or impetus is the strongest The USA has encountered in nearly thirty
years. As well, the Nation's financial system has more weak spots for
the Fed to worry over. For now, the policy seems to be to maintain
money and liquidity growth at moderate rates and to let inflation
pressure cut into growth so that the resulting slowdown will create
enough slack to cool inflation pressures and allow the Fed to ease up on
the monetary reins subsequently.
As of now, the data suggests the economy may slow in the months
ahead but that inflation stimulus still remains strong, particularly in
the fuels sector. Since there is slack already in the system, the policy
still has a reasonably good chance to work.
Now the hard truth is that during these inflation containment periods, the
stock market can easily decline by 10 - 12% even if the program is a
success, as uncertainty during the process can take a toll. Thus, it
should be no surprise if the S&P 500, already down 5.5% from the recent
interim high, falls another 5 -6% to the 1085-90 area. Much should
depend on how fast we see progress on the containment front and how
confidently investors react.
Success here is very important. Giving the economy "room" to expand
another three-four years will help fill the US Budget coffers with regular
income revenues as well as capital gains taxes from a rising market.
I have us as remaining in a cyclical bull market in the USA. True
enough, the market is no higher than it was a year ago, and has
been in a correction phase recently. But the action of the market
is merely repeating what happens after the powerful initial phase
of stock price and profits recovery in the wake of recession. Once
profits complete a "V"pattern recovery and move into the expansion
phase, it is common for inflation pressures to intensify and for interest
rates to begin to rise. This is what we experienced over 1964-66,
1973, 1983 and 1994.
The process of inflation containment has grown easier over the years
for three reasons: 1) The Fed has learned to move more forcefully;
2) It has attacked inflation earlier in the cycle; and 3) accounting and
tax policies have made inventory speculation less attractive for
businesses. The Fed did fail to extend the expansion and the bull
market over 1973-74, as companies pursued aggressive inventory
speculation via FIFO accounting -- "first in, first out" -- which led to
large but unsustainable earnings gains, inventory imbalances and
recession.
The process of inflation containment to extend economic growth and
the bull market could be difficult this time. The current inflation impulse
or impetus is the strongest The USA has encountered in nearly thirty
years. As well, the Nation's financial system has more weak spots for
the Fed to worry over. For now, the policy seems to be to maintain
money and liquidity growth at moderate rates and to let inflation
pressure cut into growth so that the resulting slowdown will create
enough slack to cool inflation pressures and allow the Fed to ease up on
the monetary reins subsequently.
As of now, the data suggests the economy may slow in the months
ahead but that inflation stimulus still remains strong, particularly in
the fuels sector. Since there is slack already in the system, the policy
still has a reasonably good chance to work.
Now the hard truth is that during these inflation containment periods, the
stock market can easily decline by 10 - 12% even if the program is a
success, as uncertainty during the process can take a toll. Thus, it
should be no surprise if the S&P 500, already down 5.5% from the recent
interim high, falls another 5 -6% to the 1085-90 area. Much should
depend on how fast we see progress on the containment front and how
confidently investors react.
Success here is very important. Giving the economy "room" to expand
another three-four years will help fill the US Budget coffers with regular
income revenues as well as capital gains taxes from a rising market.
Saturday, April 16, 2005
Introduction
I set up this blogspot for a couple of reasons. One, I'm no longer a spring chicken, and I find that writing helps me tighten the logic of my thinking. Two, we are now moving through a
transition in economic drivers and the investments marketplace that will usher in a markedly new era on a global basis. I want to provide current perspective, but I also want to start looking
ahead at prospective dramatic change that is coming at us, but which is now only barely discenible. The era from 1980 - 2004 was well defined early on in both the global economy and the capital markets. Once you saw the shape -- broadening global growth with decelerating inflation and falling interest rates -- investing became like shooting fish in a barrel. But now, a period of accelerating change lies ahead, with all the pitfalls and opportunities it will bring for investors. I hope you will follow along as we start to look for and define the markers of great change.
transition in economic drivers and the investments marketplace that will usher in a markedly new era on a global basis. I want to provide current perspective, but I also want to start looking
ahead at prospective dramatic change that is coming at us, but which is now only barely discenible. The era from 1980 - 2004 was well defined early on in both the global economy and the capital markets. Once you saw the shape -- broadening global growth with decelerating inflation and falling interest rates -- investing became like shooting fish in a barrel. But now, a period of accelerating change lies ahead, with all the pitfalls and opportunities it will bring for investors. I hope you will follow along as we start to look for and define the markers of great change.
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