The Moose Stays in Cash

From www.decisionmoose.com
By William Dirlam

JUL 18— The WallStreet Journal raised its newsstand price to two dollars this week. With Starbuck’s lattes going for five, the price of morning coffee and a paper, for those who want to be both trendy and in the financial know, is now seven dollars. Not Lira, not Pesos, not Yen… Dollars. Seven dollars for coffee and a newspaper! No doughnut. No OJ. No Russian Tea Room atmospherics. Just a stimulant made of beans and a depressant made of wood pulp.
All those government types who’ve been telling us that inflation from food and energy had not passed through to the general economy obviously drink instant and don’t read. Not that I know that much about Starbuck’s or favor the Journal myself. Frankly, I prepare my own coffee and get my written news off the internet. Sometimes the coffee is Starbuck’s, which I buy at Costco. Most times it’s just grocery store fare. I do grind the beans fresh each day now, which I admit to have considered effete when I was young enough to think coffee was hot tap water over a spoonful of Folgers Crystals.

In retrospect, my one visit to Starbuck’s was traumatic enough to make it my last. First off, there were a lot of truly wired people in the place, and their palpable nervousness seemed like it might be contagious. (Are fidget-cooties airborne? I didn’t know.) I also felt like a clueless tourist in Bhutan, entirely unfamiliar with the language and customs. So while I was trying to translate the Franco-Italianate menu and determine which of the hyperactive barristas I should talk to first, I was nearly trampled by a stampeding pack of caffeine-starved customers.
Let’s just say that I was clearly trying everyone’s impatience.

When my two-cup $8 order finally came (I’d gone there at a friend’s request) I nearly caused a fist-fight by accidentally picking up another guy’s coffee (which was sitting next to mine) and polluting it with sugar before he could hiss at me that they put all the orders on the counter at once in no particular sequence, and that I had ruined his life. Excuse me, but all the cups look the same on the outside, buddy. Since I’ve rendered your grande-black-quadruple-caff entirely undrinkable, Mr. Type A freakazoid, let me buy you another.

So I netted out at $12 and some serious stress for my two cups of Starbuck’s. Nowadays, I guess it would have been $15. I got off light. Even so, I’ve never gone back.

Given $5 coffees and $2 daily newspapers, it was somewhat comforting to see the latest consumer and producer price indices confirm what most of us have encountered in the real world for the last year. At least we no longer feel as if the govmint is lying to us. That was about the only comforting thing, however.

Inflation is not only alive and well, but, as we’ve noted here for some time, has been bulking up on the monetary steroids coach Ben has been pushing behind the Fed clubhouse. Wholesale prices are up 9% year-over-year, and consumer prices are up 5%. We’ve only just begun.
This week’s market action generally followed the post-bailout relief scenario outlined here last week. Once the Fed, the Treasury, and the SEC made guaranteed safety-net sounds over Fannie and Freddie on Tuesday and Wednesday, the relief sent recent history into reverse. Stocks rallied, interest rates rose, the Dollar gained, and gold backed off, all later in the week— all as predicted.

The only unexpected development was that non-precious metals commodities did not rally along with stocks. Normally stocks rise in anticipation of a stronger economy and this tends to push materials prices higher too. It didn’t happen that way this time (the divergence, in fact, was very stark), which suggests one of two possibilities.

Either the market considered commodities, especially oil (down 11%), short-term overbought going into options expiration and took profits, expecting to get back in synch with stocks in the coming weeks. Or the market saw the rally in stocks as a short-covering exercise instead of a prediction of an all clear in financials and stronger growth ahead, and sold commodities in anticipation of a global recession.

There is ample evidence that the sharp move in equities this week was a government orchestrated short-covering rally, particularly the historic surge in financial stocks. The SEC announced an emergency order banning naked short sales in the financials, and the most shorted sector responded brilliantly. Even though naked shorts were already illegal and have been for a long time, financials (XLF) rocketed 20% higher in three days. It was an historic move for a beaten-down sector, but it showed just how clueless the market remains, both about values in the sector, and about the impact the shifting rules (or confused jawboning) of an increasingly activist government may have on the trading process.

Still, when you look at comparative interest rates, the Fed Funds rate is about half the European rate and less than half Britain’s. Dollars are cheap, but once you own them and throw global inflation into the mix, you realize they are less than worthless. You get rid of them as quickly as you can by buying something, and since commodities are traded in Dollars, they have been a convenient haven. Once global growth slows, however, and you have less need to take delivery of commodities, you shift to precious metals, which are a more permanent store of value.
Fed Funds futures were all over the map this week— going from a 58% bet that the Fed would HIKE rates by 25 basis points before December to a bet that they would CUT rates by 50 basis points, to a bet that there would be no change. Whatever, the Dollar’s outlook is dicey. If anything, all pretense of an inflation-fighting Fed appeared to vanish in the face of an increasingly desperate financial situation.

I’m certainly in no position to second-guess the wisdom of the Fed. I can’t even navigate a Starbucks. I’ve been evaluating the Fed Check, however, for some time now, and it’s forecasting ability still appears robust. If anything, this Fed’s propensity to do the opposite of what the commodity and bond markets are telling it has reinforced my theories about what happens when they act that way. To tell the truth, this Fed has kind of hit us over the head with it.

In retrospect, the Fed missed a chance to cut rates in 2006, and by standing pat, flattened the yield curve, which curbs bank profitability. While that didn’t create the sub-prime banking crisis a year later (Greenspan’s far larger miscues did that), it certainly didn’t strengthen the banks going forward. Then, once the crisis hit, the Fed ignored strong inflation signals in late 2007, and chose to cut rates to protect a weakened banking system. In fairness, it was a damned if you do, damned if you don’t call, but it has led to increasing inflationary pressures, which, if theory holds, won’t be peaking until a year after the cuts stopped— i.e., next spring. Thus, commodities and gold still probably have legs.

There are a couple of ironies in all this that should be mentioned. One is the most obvious, which is that the more government screws up, the more power it feels it needs to rectify the situation. I mean, do we really need to give Bozo bigger, redder shoes? Two days of Congress, Fed, Treasury, and SEC on the tube was an ego boost for them, I’m sure, and for me too (although it was an “eyes-glaze-over” type e.g.o. thing for me). But apart from face-time in an election year, what did they accomplish? I’m still waiting.

The second irony is mostly hypothetical. If the Fed acted in concert with bond and commodity markets to dampen swings, instead of in opposition, it would be more effective in stabilizing growth and inflation. That would reduce market volatility, but make both forecasting and trading more difficult. So while the American in me would like to see them get it right, the Moose in me isn’t so sure. If they weren’t messing up the markets so obviously all the time, I might not know what to make of it.

Trading aside, I do think a more compliant Fed would bring back investing. This past week alone is ample evidence that the investor has fled our markets. Stocks plunging 20% one Friday, and then surging 20% by the next is more like manic depression than planning for the future, which is what investing is supposed to be all about. There are enough exogenous forces (weather, terrorism, war, cartels, earthquakes, etc.) pumping uncertainty into our markets without our government magnifying their impact.

As for this week’s signal, several very perceptive Moosaholics have asked why, with cash in first place and GLD in second, given that GLD is POS short and medium term, that it is not the current choice. The reason is author discretion, and indecision. (If you think you hear a feint “puck, puck, puck”, that is the chicken on my keyboard.) Let me explain.
When I first developed the model, there was no gold (GLD), only gold shares (ASA), which behave very differently from bullion-- more like stocks than a commodity. So when the Fed Check, as it does now, said “avoid equities”, I would avoid gold shares. No brainer.

When I substituted bullion for gold shares a couple of years ago, although I did not have enough back data to check my assumption, I reasoned that GLD should be exempt from the Fed Check's occasional blanket aversion to stocks and bonds (promises) because it was a hard asset (reality).
As it turned out, bullion has occasionally gone down (25% of the time) when the Fed Check was predicting paper would. It seems that when stocks go to hell in a hand-basket, people sometimes sell the good stuff to cover or raise cash. The baby can get thrown out with the bathwater. That said, GLD recently gave the Moose a preliminary buy signal (three weeks ago), pre-banking crisis. Longer term, it should be headed up.

The model generates a “confidence number” for each asset, however, based on the tape, the market, and the Fed, and GLD’s remains just below a “Confirmed Buy”. Now I'm waiting for a price pullback since, as the Bear Stearns case suggested, gold retreats once a "crisis" is averted. I'm not sure this latest Fannie-Freddie credit crisis has been averted, but if the market thinks it has, gold should correct as stocks rally. In a week or two, GLD may be a buy.

There’s a reason the banking crisis broke a year ago. It’s because this is when the banks release their quarterly statements after the spring real estate mortgage season, when all the 1, 3 and 5 year ARMs roll over, or as we’ve seen lately, go belly-up. This year, we’ve gotten some numbers that stink, but our noses expected worse. We still have another week, though. The better the banks report next week, the stiffer the correction in gold. Since Citibank got a standing O for “only” losing 2.5 billion this week, the bar defining success is obviously set pretty low (underground). Might as well wait.

The thing is, when I get too fancy (and the above reasoning is fancier than a gigolo in room full of dowager aunts), I usually find I’ve been too smart by half.

Nevertheless, another week in cash. Worst that can happen is we miss out on the chaos. In my view, a small price to keep one’s pants dry.

Some of the funniest commentary from Bill yet. The gigolo analogy is classic. I have commented on Bill's methodology & website previously and reiterate that it is one of the best. Thank you Bill for all that you do.

The Moose stays in cash

courtesy Bill Dirlam of www.decisionmoose.com

JUNE 27— Nobody ever wants to jump in front of a dump truck, or for that matter, a central bank announcement, so the markets stay to the curb and wander aimlessly until the Fed’s midweek press release. Then they go nuts the last couple of days trying to figure out what it all meant. Fed meeting weeks are always a bit schitzo, and this one was no exception.

The Fed’s Wednesday message turned out to be the same one the Moose has been pushing for several months: stagflation. Moreover, the Fed appeared to reassert its emphasis on the “stag”, as in stagnant. Observers figured the bank’s governors (with one dissent) still feel that the weak economy and the fragile banking system must take precedence over a growing inflation threat.
After sleeping on it for a night, investors, fearing slower growth and weaker profits, dumped stocks on Thursday, knocking the Dow down 358 points to a two-year low. Money fled into bonds for safety, driving down yields, which in turn weakened the Dollar, spiking commodity prices and gold.

The Fed’s apparent notion is that our economy, beset by high energy prices and beholden to a financial system that is too strapped to make new loans, even if it wanted to, will ultimately weaken enough to curb inflation on its own. Needless to say, that is hardly a comforting thought for stock investors.

Remember that scene from “Butch Cassidy and the Sundance Kid” when the two realize that they have to jump off a humongous cliff into a raging river to escape a posse? Sundance refuses to jump, confiding finally that he can’t swim. Butch replies incredulously, “Are you crazy? The FALL will probably kill ya!”

Inflation? Hell, the ECONOMY will probably kill ya. Thanks, Ben. Very reassuring.
After jumping off the cliff Thursday, stock investors went down a small waterfall Friday (-104 Dow points) but then managed to dog-paddle to shore. It wasn’t a pretty two days, but better than expected consumption and personal income data for May on Friday morning blunted previous fears of imminent depression. (Can you say “tax rebate checks”. How about “one time shot”?)

For now, technical indications are that stocks are temporarily oversold and ready to bounce-- although volume and volatility measures are not entirely conclusive. End-of-quarter-new-quarter follies on Monday and Tuesday can be expected, however, and don’t forget the ECB.
As noted earlier, no one wants to jump in front of a central bank announcement, and the European Central Bank is up next week. Moreover, the ECB decision has become more problematic. They have been the toughest talker on inflation, practically promising a rate hike next week, but lately European economies, led by powerhouse Germany, have begun to show signs of cracking. Stagflation is creeping into the global consciousness.

Whether the ECB will choose to maintain credibility and raise rates as expected, risking recession, or reverse itself and hold steady awhile longer has suddenly become an open question. The ECB only has one mandate—- to fight inflation. It does not have to concern itself with growth and financial stability as the Fed does, although it would be foolish not to consider those things. Whatever the decision, it could have a bigger impact on the investment markets than the Fed’s decision did.

Thinking is if the ECB raises rates, increasing European bond yields’ attractiveness relative to Treasury yields, the Dollar could slide further short term. That would push commodity prices (which are denominated globally in Dollars) higher for U.S. consumers and those in nations whose currencies are tied to the Dollar (China, Saudi Arabia, etc.) U.S. stocks would be vulnerable to more on the downside.

How much of this week’s action is anticipating just such a development is unclear. We won’t know until after the announcement. That’s why folks step back from dump trucks and central banks.

Higher Dollar denominated commodities do not necessarily mean higher euro-equivalent commodity prices, however, and an ECB rate hike would dampen European demand, lessening inflation pressures there. Eventually, that might lead to a slowdown and a weaker euro, provided of course the U.S. is not in a death spiral itself at the time. Since we’ve been six to nine months ahead of Europe for awhile now, nothing is a lock in that regard.

The problem for both the U.S. and Europe is that the excess demand generating the current round of inflation is originating in the emerging markets. The Fed or the ECB playing with interest rates in quarter point increments will not have a direct impact on that demand anytime soon. We have to go through our own demand first to get at theirs, and that can be painful. It can be done, but only if there is enough political will.

The emerging market boom, after all, was born of Greenspan’s 1% Fed Funds Rate, a rate that was lower and kept in place much longer than commodity and bond prices indicated was necessary. Lower U.S. rates essentially make more Dollars available, and since commodities are traded in Dollars, more Dollars chasing a finite amount of goods raises prices. Commodity inflation was born. More accurately, at one percent interest, it was shot out of a cannon.
Since the current Fed has basically ignored market prices from day one, it comes as no surprise that imbalances have developed over time. (Note to Congress: the Fed has done more to spike oil prices of late than any commodities speculator.) In fairness to Bernanke, his predecessor left him with some truly impressive time bombs (like the emerging markets boom, sub-prime and the housing bust, and incipient global commodity inflation). His choices have been difficult. I am thankful that they were not mine. (See ya. Wouldn’t wanna be ya.)

Unless there is a global economic collapse, I’m afraid that the Fed, by ignoring the markets’ inflation signals for almost a year, may have brought us to the brink of the worst inflation we’ve seen in this country in thirty years.

Now mine is only a theory, and I sincerely hope that I’m as wrong as a panty raid at a Vatican convent. If I’m right, however, you’ll want to own gold (to preserve your capital) and several cases of bourbon (to preserve your sanity). No stocks. No bonds.

It might take awhile-- and considerable anesthesia-- to get through, but we will. One day, ten years from now, on a boardwalk by the sea, as you’re blissfully licking a twenty-dollar ice cream cone, you’ll have forgotten all about it.

The Moose continues to hold cash. Bill runs one of the best mid term models with Decision Moose. His humor is as funny as his analysis is insightful. Thank you Bill for all that you do!