Here’s the news of the week – and how we see it here at McAlvany Wealth Management:

Inflation: The Not-So-Good Kind

We keep hearing that there is no inflation anywhere. The Fed is confident, the markets are high, earnings are good, real estate has stabilized, and so on and so on. Stability has returned. Why then, wherever you look, do you find headlines to the contrary? As we perused the news headlines and research periodicals, news of inflation and the nasty side effects it brings are plentiful. Here are a few that caught our eye:

    China tightened credit and hiked interest rates further to stave off inflation, from 5.81 to 6.25%

    Philly Fed Survey – released Jan 20th, showed the highest inflation since July 2008 (54.3 in Jan vs. 47.9 in Dec. ’10 for the prices paid component). The survey also showed the largest jump in inventories for the last six months.

    General Mills hiked prices on snack bars 7% last week, while Kellogg’s saw a comparable increase in its snack bars. Also Kraft reportedly announced a 6% increase on select Planters branded nut products.

    Illinois has raised corporate taxes from 7.3% to 9.5% and individual taxes from 3% to 5%

    Brazil has lifted rates 50bps to 11.25% to fight off inflation.

    CPI for December came in a higher than expected 0.5% vs. expectations of 0.4%

    Inflation did not boost retail sales in December. The increase of 0.6% in December was very disappointing, 0.8% was expected – adjusted for inflation it would have been worse – which the commerce Department does not do. This reveals a disturbing trend, that consumers are making a shift in spending patterns.

    The rise in gas prices (15.79% in the last two months) has beaten down consumer sentiment in January, overshadowing an improved job outlook and passage of temporary federal tax breaks. University of Michigan sentiment slipped to 72.7, below 74.5 in December.

    Unilever (one of the largest food companies in the world) Chief warns over global crisis in food output – prices are soaring and demand is outstripping supply.

    Concern that ETFs are playing a bit part in soft commodity (food) prices is escalating. ETFs hold food for investment purposes instead of consumption – a by-product of Fed easy money policy.

    The Treasury 2- to 30-year yield curve widens to a record on inflation prospects. The curve steepened to a 3.96 percentage point’s vs. 2.07 for the past ten years.

    Steel prices rise on inflation concerns – prices have risen 23.22% in the last two months.

Once again, when trillions are printed and prices rise in a relatively low wage growth environment (for the masses, not the rich), spending and profit dynamics change – and not for the better. (This is not to be confused with the good kind of inflation seen when an economy expands while costs are falling, 1982-1998.) What are the chances this will change, you might ask? They appear slim to us. While other countries see the risks of rising prices, and, one by one, take action to circumvent the risks, the U.S. and Europe continue to be held hostage by the banks and their chronic solvency issues.

Former bailout efforts are failing. Greece, Spain, Ireland, Italy, and Portugal are all in the same perpetual state of need – borrowing to pay off previous borrowings. Here in the U.S., besides the bad mortgages and the Federal deficits, the municipalities and their $2 trillion problem are gaining speed towards bankruptcy. Government officials are already discussing ways to “bail out” the states once this happens. At the consumer level, Christmas sales were not as good as hyped. Retail sales were a disappointment, as noted above. Credit card usage was seen as a positive – up 5.5% during the season, according to Visa – but this is typically seen as a sign of weakness as shoppers opt to delay payment.

Earnings season looks mixed so far. Tech companies are doing the best, but inventories are rising fast, lending to the belief there was substantial channel stuffing during the months in and around the holidays. Financials are showing very mixed results; companies that showed expectation-beating profit were either the beneficiaries of Fed monetization efforts or they reversed loan loss reserves (a 2008 and 2009 phenomenon), adding them to earnings to boost the bottom line.

We continue to believe this is another 2008 in the making. Back then, record high commodity prices and a small rise in interest rates were enough to suffocate the speculation in the markets. As we gaze upon prices and rates that are even higher now, we can’t help but feel we are in the same place as before – with a few exceptions. Unlike 2008, leverage in the precious metals is not as prevalent. Therefore, the metals may be in a much better position to withstand systemic market pressures than before.

Have a great weekend.

David McAlvany
President and CEO

David Burgess
VP Investment Management