Here’s the news of the week – and how we see it here at McAlvany Wealth Management:
1. There’s a Tear in this Beer. The Guinness is likely to be flowing on the Emerald Isle. There will be a little more free time between 8 and 5, and the local pub’s as good a place as any to meet with friends and commiserate. This week, the IMF has pegged the Irish unemployment rate at 14.5% by year-end – up from an earlier estimate of 13.5%. Using John Williams’ numbers, the US unemployment figure of 21.6 % may argue just as well for a spirited pre-election Obama stimulus package – let Budweiser flow in the streets.
Additionally, Moody’s left Ireland on negative watch after dropping the country’s debt rating two notches, now just above junk status. Comparing Irish paper to German, you find five-year notes yielding 7.39% more than German paper of the same maturity. This is not what you would call the luck of the Irish. Better days may lie ahead, but they are no doubt well into the future.
Meanwhile, the deficits and debt in Greece have remained big and fat, and have brought the unfortunate Olympic state to a less-than-stellar end-game. Even with austerity measures in place and bailout dollars flowing, it appears there is going to be a “renegotiation of debt.”
Isn’t it lovely sounding? The phrase even implies mutual consent by the creditor and debtor. Renegotiation is like other euphemisms that cause us to smile – or wince. Default is default, but we can at least add pleasantness to the experience, if only linguistic in nature. The FX markets know full well that the clock is ticking, and one domino does not fall in Europe without other party states being subsequently impacted. We watch Spain closely, but fear that the Greek renegotiation will have even more far-reaching consequences: mountains of that debt (about to be discounted) simmer like Vesuvius on the balance sheets of Italian, French, and German banks.
The debt liquidation cycle is alive and well in Europe, and the twin horns of the ECB’s dilemma are taxpayer revolt at the polls and capital destruction in the banking sector. How would you bet on the outcome – bankers helping bankers, or not? With monetary solutions being centralized at the ECB and peripheral countries getting pressured yet again, we guess that a revolution is afoot – perhaps crossing the Mediterranean as we speak. Can the EMU remain as it is? Will there be countries either forced out or voluntarily hitting the exits? These sound like good questions to entertain over a Guinness.
Closer to home, we are so very relieved by the serious-minded budget debate taking place in Washington. They are more serious about spending non-existent, but soon-to-be-conjured, money than ever before – and I suppose they are being mindful in some strange way. Mindful of re-election, that is. With an initial effort last week solving 2.4% of the problem (stated cuts subtracted from this year’s estimated deficit), we are more encouraged by the Ryan plan, which leaves our gross national debt growing by only 28%!! That’s a victory … right? Take the national debt from $14.3 to $18.3 trillion in a decade, instead of the $24.3 trillion course we are on now (according to the Congressional Budget Office) and you’re a hero. That’s the best case.
Obama is equally generous to his voter base (surprise, surprise), but at the greater expense of the balance sheet, leaving the national debt at $20.3 trillion. We too share the European ailment of welfare statism, the cure being too unpalatable to be taken voluntarily. So, the charade, I mean debate, continues to the satisfaction of most voters, even as we approach an inflationary abyss.
2. A “Blip” – is now a highly technical term used in finance, apparently. That’s what Bernanke is calling the rise in commodity prices. In a response to a question after a speech given in Stone Mountain, Georgia, last week, he said, “I think the increase in inflation will be transitory” and that it’s more a result of “global supply and demand conditions.” Comments made by the Fed in this week’s release of the Fed Beige Book also corroborated this view.
Other Fed governors share the same sentiment (but with a rising dissenting vote). In an article released by Bloomberg on Friday titled “Fed Policy Makers Differ Over Policy as Inflation Picks Up,” Fed governor Elizabeth Duke said that “rising commodity costs aren’t resulting from U.S. [Fed] monetary policy and do not warrant higher interest rates.” On the flip side, Jeffrey Lacker, Fed governor of the Reserve Bank of Richmond (while at the University of Baltimore yesterday) said, “I believe we need to heed the lesson of the last recovery that inflation is capable of rising even if the level of economic activity has not returned to its pre-recession trend.”
Although policy makers were split at their last meeting on March 15, the vote still tipped (at best 4 out of 12 dissenting) in favor of policy “accommodation” past 2011. So it seems that we’ll have QE to infinity, despite, if you’ll recall, the tough talk about “removing stimulus” just a few weeks ago. Could it be, Mr. Chairman, that the reason for the “modest” economic recovery is because of inflation crimping the profits and disposable incomes in the system?
It’s clear they don’t see facts, and for the time being have chosen to ignore the dynamics of inflation we have discussed here repeatedly. So when and where will the tipping point occur? Sooner than the Fed supposes, in our opinion.
Below I have provided a chart of the CCI commodities index. It now stands as the best-performing index of all the major asset classes (stocks, bonds, real estate, and cash). The attribute of note is its price relative to 2008 when the first leg of this crisis came into being. It now stands at 10.5% above pre-crisis/peak levels, while the Dow and the Dow Jones Real Estate Index are 12.4% and 36.2%, respectively, below their pre-crisis highs. Bonds of course are struggling to break even over the last two to three years, and cash is still yielding next to nothing for those seeking its safe-haven attributes.
The second chart, below, is of the same index, but from a longer-term perspective (starting in 1970). Notice that this “spike” in commodities is not normal, and the last time we witnessed a similar move in percentage terms (250%) over a nine year period was between 1971 and 1980. Back then it was called inflation; today it’s called “healthy” within the context of a “recovery.”
Perhaps Bernanke is hoping that one of two things will happen. First, that commodity prices will rise to a “breaking point,” in which the markets will turn over again as they did in 2008 – therefore causing the need for more stimulus. Or second, that supplies of various commodities will catch up to demand (whether artificial – caused by a buy-ahead mentality – or real).
Unfortunately, the second option – which may happen over time along with the first – plagues us with the same over-supply/solvency issues experienced during the housing crash. Once again, we’ll have a scenario that favors the inelastic supply side nature (lack of supply) of the precious metals in the long run.
Next week, we will have more to say about the earnings season now under way. So far, profits and revenues have disappointed to some degree, with markets mildly down in response – higher costs are the suspected culprit.
Thank you and have a great weekend!
President and CEO
VP Investment Management