Here’s the news of the week – and how we see it here at McAlvany Wealth Management:
1. Stock Up on Tums. Price forecasts are dependent upon a consistent unit of account. If I say that oil is going to $150.00 a barrel, you might place that projection in the context of supply and demand, a geopolitically destabilizing event in the Middle East, or perhaps investor capital driving the price. But if I say that oil is going to reach $2,000 a barrel, you’ll either consider me a wing nut or conclude that I see a possible currency event (super-inflation or hyperinflation) looming.
With our unit of account (the dollar) sliding in value, it’s nearly impossible to predict where any market will be in the coming months and years. DOW at 6,000? 36,000? Gold at $1,500? $12,000 or $120,000? When the dollar confidence game is ultimately challenged, keeping in mind a positive real rate of return (what you keep after taxes and inflation) will be critical. It is already critical. An improvement in nominal terms may or may not be an improvement at all.
We will continue to emphasize relative values as we attempt to measure whether or not real purchasing power has been preserved. Clearly, in the back of our minds, we are concerned about the inflationary experiment we are being ushered through by the Fed and the Treasury.
Speaking of our favorite duo, we are finding it odd that the job description of the Treasury has been confused by those at the Fed who have taken on the role of financial asset expropriation. This illustrates the point that inflation is but another form of taxation – factor this into your effective tax rate (and then grab the Tums).
By setting rates low and not accounting for a high cost of living increase (10.7% is a solid number), bank deposits and cash assets are running a negative rate of over 10%. In other words, the financial system repair that the Fed is attempting is being effected on the backs of dollar and fixed-income investors. Artificially low rates are not merely an inconvenience; they are a redistribution of capital – a tax. Did you think you were paying 35% of your income in Federal taxes? By distorting the yield curve and understating inflation, the fab duo subjects you to an unannounced income tax rate hike of 10% on top of the 35% you already knew about. You work for the government from January to mid June (which does not add in all the other ancillary taxes you pay). A happy thought, I know, but worth noting as we head into your half of the year.
Individual stocks are now looking ugly as we witness 10-30% declines (RIMM, RL, GPS, HPQ, AIG, C, just to name a few). Internals for the Nasdaq are deteriorating, with more companies reaching 52-week lows than 52-week highs – even though the price of the index has continued to rise, pushed higher by a few big names. When only a few flagship names are carrying an Index, watch out below.
In the coming weeks – certainly prior to August – we will be adjusting all portfolios and preparing for quite a bit of volatility. We will endeavor to maintain position limits that keep volatility at reasonable levels and a cash position that, in spite of being dollar denominated, will give us the flexibility we need to protect your assets in what we consider a challenging market for most asset managers. We don’t mind the challenge.
On a side note, if you have a lifetime objective in physical gold and silver ounces, you’ll want to swap a few fiat notes for those ounces before August, as well. We’d say “beware the Ides of March,” but it’s the remainder of 2011 and early 2012 that may hold significant disclosures and market reactions. Batten down the hatches, and, as we mentioned earlier, learn to assess all your assets in relative rather than absolute terms.
With a rollover in Equities anticipated, we expect to see the usual rotation to the “safer” asset class – bonds. This rotation has become both less compelling and less forceful in volume terms as the decline in rates (inverse of the bond price rising) has seen higher lows on each rotation to bonds: 2.65%, 3.5%, and an anticipated 3.75% on this rotation.
A growing number of market participants are concerned with balance sheet reliability and a compromise of credit quality, as and when real transparency is forced on various sovereign entities. It is often what you are unaware of that can hurt you. There is far more toxicity and frailty at the Fed than most people are prepared for. With that in mind, more and more investors have to hold their noses when making the purchase of Treasuries. Following the aforementioned rotation to bonds, and the Fed’s panic to prop up asset prices in the equity market, a rip-roaring inflation is likely to ensue.
Moody’s downgraded Greek paper to Caa1 from B1, with a negative outlook. That puts the probabilities of default at 50% over the next five years (five months, if you ask us). At the same time, Moody’s is suggesting a downgrade of US debt from AAA status if the debt ceiling is not raised. (How does adding more debt improve your credit quality?)
Temporary concerns with debt liquidation and default will drive a temporary shift to the Treasury market (and may in fact boost the dollar marginally) in spite of balance sheet insolvency, which should be followed by a lethal dose of liquidity and the start of an uncontrollable inflation. The Fed has gone too far, and our fear of monetary madness is now in view on the horizon.
2. Fed “No News” Period. The economy is not agreeing with the “experts.” This is obvious now, and the Fed is on hold with respect to QE3. In commentaries past, we have gone to great lengths to dispel the consensus view that a “real” recovery was in fact at hand. This was done in an effort to quell any concerns over our “defensive” positions. Often, the markets can coax investors into believing a false theme simply because the herd is charging relentlessly in one direction.
This has been the case for many chasing the dream (the recovery) the Fed has effectively portrayed for the last few years. Put in monetary terms, commodities are simply more expensive now relative to the whole of stocks, bonds, and real estate than they were before the crisis began in 2008. Anyone willing to “convert” at this juncture will simply have to pay even more for the privilege. The net cost of the Fed’s deception: a reduction in the standard of living for the masses in general, especially for those living on a fixed income.
With these things in mind, it’s not going to be all that helpful to detail the economic events transpiring – even the bubbleheads on TV have shifted their focus to the growing negatives in the data – so I will try to abbreviate the economic news to some degree while shifting focus to how the markets are responding.
In sum, the economic releases revealed more of the same. Case-Shiller Composites continued to point to more weakness and/or stagnation in housing. Manufacturing data continued to plummet by as much as 16% MOM, depending on which release one looks at. The jobs data also grossly disappointed, taking down consumer confidence in tow.
The ADP employment change showed 38K jobs created vs. 175K expected. The anemic showing included temporary jobs! May U.S. nonfarm payrolls released today were just as bad, with 54K jobs created vs. expectations of 165K. People also worked longer hours for less pay, while the overall unemployment rate increased to 9.1% from 9.0% – this despite the fact that 203K fictitious jobs were created through the “birth-death” model. Jobless claims worsened in the latest week, and retail data showed very little improvement. Gains as usual were derived from inflationary price gains (in gasoline).
Across the seas, it looks like Greece will impose austerity measures in exchange for a bailout loan from EU sources. Moody’s still downgraded Greece, while CDSs in Greek debt markets have barely shown any improvement on the bailout news. The general conception here is that Greece will eventually declare bankruptcy, regardless of what are deemed as short-term fiscal solutions. Manufacturing data from China to the euro region and the UK also slowed in May due to rising commodity prices and regional shocks. French shipping rates dropped significantly as cargo levels continue to shrink.
As Dave M. mentioned above, U.S. markets (and those abroad) are responding in the traditional manner. Stocks are sold, breaking below their respective 100-day moving averages, while bonds and cash are bought. So far, though, the selling pressure on the former has been greater than the buying pressure on the latter. Panic therefore eludes the markets, while waiting, we think, for the almighty Fed to render its QE verdict. Its next press conference is slated for June 22, at which time we should have a better idea as to its position. If we were to take a guess as to the outcome, we would lean in favor of continuing QE. Price declines (in CPI, PPI, and excess inventory markdowns) are commonplace in contractions now underway – allowing the Fed free license to print, for the time being.
There are a few observations worth mentioning about the metals. Gold continues to hold nicely above its 50-day moving average, unlike industrial counterparts such as copper and aluminum. Silver has had the tendency to get clubbed (losing 5.3% this week), along with stocks, for the same reason. It is assumed that after the industrial issues are exhausted from silver, monetary demand will then assume control. So far, silver’s 100-day moving average has been where the battle lines have been drawn. We would like to remind you that the Fed’s decision to QE or not to QE should be irrelevant to the long-term prospects of the metals. The U.S. is trying, like Greece, to avoid eventual bankruptcy. This means our currency should eventually discount whatever fiscal reality occurs and propel the metals higher in dollar terms – whether anyone can afford an ounce or not.
With the inflation-adjusted price of gold currently resting somewhere in the range of $2400 to $2800 an ounce (or more, based on CPI or PCE data), it is still clear that past monetary crimes or indulgences have yet to be fully discounted in the price – much less any upcoming events anticipated. Therefore, worries as to what Fed might or might not do in the near future will most likely prove irrelevant in the long run.
Have a great weekend!
VP Investment Management
President and CEO