Thursday, April 24, 2008

Its Official: The Market has lost its Mind/Inflation

What a wacky world we all live in. It seems the worse the news gets the higher stocks move because everyone keeps saying to themselves "ok NOW we have seen the bottom".

This mindset is also being heavily sold by the snake oil salesmen on Wall St. Hour after hour on CNBC you keep hearing that stocks have already priced in all of the bad news. So as a result, any bad news is good news and stocks move higher.

Another theory you hear from these talking heads is that the Bear Stearns sticksave by the Fed was the peak of the crisis, and we are now past it and the Fed will be there to fix any other bumps in the road.

The pigmen also love to compare this to the Long Term Capital Management crisis where Wall St. bailed out one fund which resulted in a quick market rebound. None of these are compelling reasons to buy IMO. It sounds more to me like gambling than investing.

Buying on a 10% correction and "hoping" its a bottom is a very dangerous investment strategy when you see all of the risks that are out there. Investing should be based on fundamentals not "hope".

If you think the end result of what some are calling the biggest financial crisis since the Great Depression is a 10% correction then you need to have your head examined. Stocks drop an average of 28% during an average recession, and this is going to be a nasty one.

Consumer led recessions are different then business led recessions. They tend to last longer, and when you throw inflation into the mix, they tend to be even worse. The main reason they are long is because it takes time for people to pay off debt and find new jobs and recover. We also now have the inflation that will eventually have to be killed via interest rates and this is going to take time.

I read a great piece in the Financial Times today on:


Killing inflation is going to be as important as recovering from the housing mess when it comes to saving the economy long term. What I am becoming concerned about is the Fed is looking at the wrong indicators when it comes to gauging inflation. I picked this up from The Financial Times.

This is a brilliant commentary. Here are some pieces:

The Thesis:

"Today, what happened in the developed world in the 1970s is happening in the emerging markets, which are now a much weightier chunk of the global economy.

Developing countries' central bankers have been slow to respond to the rise in food and other commodity prices.

After a long period in which emerging market economies were operating with much excess capacity, the gap between actual and potential output has dwindled. Headline inflation rates are rising.

Energy and food take much more of workers' incomes in emerging markets than in the developed world. So the message in the food price riots is that these workers will soon be fighting for much higher wages.

In behavioural terms the inflation of the 1970s was about rival claimants defending their income shares. One section of the community tried to increase its share of gross domestic product at the expense of another, causing upward pressure on costs and prices.

This process has now gone global. Emerging market workers are battling for their income share. So the developed world will have to pay more for its imports."

My Take:

Alright, so the food riots are something we need to seriously focus on because FOOD is a huge cost in developing countries like India and China. Right now Food is thrown out the window when the Fed looks at inflation.

This is not an American 1970's version of inflation which the author claims was mainly fueled by unions forcing higher labor costs. Remember those steelworkers making 80k a year in 1975?

This new version of inflation will be workers in Asia demanding wage increases so they can EAT. This will then rapidly increase the costs of all the products we buy from China which seems to be everything you see in a Walmart these days.

The FT's conclusion:

"This is, then, a new, global version of the 1970s inflationary problem, in which the developed world acquires wage inflation by the back door. True, there is a strong cyclical component in the commodity boom, especially in hard commodities. This will weaken as global growth slows.

Yet something structural is clearly going on in both food and energy markets which means, as I have argued here before, that the central bankers' focus on core inflation rates that strip out energy and food prices is potentially dangerous.

For the developed countries there are also two sinister factors that are much more important than in the 1970s.

The first is the huge accumulation of private sector debt in the Anglophone economies and of public sector debt in Japan and Italy. Inflation is the easy way to reduce this debt burden provided that the inflation is unanticipated, ensuring that nominal interest rates stay below the inflation rate. Creditors are the losers from the process.

The second factor is the problem of ageing, and unfunded pensions. The cost-inflationary pressure arising from existing pension commitments and demands for increased healthcare will be on a scale that dwarfs the public spending problems of the 1970s. It will not be confined to the developed world.

So the question is, will the central bankers be able to stem this inflationary tide? As the banking bail-outs continue, I have my doubts."

My Take:

This Fed has it all wrong when looking at inflation. Food and energy have to be thrown back into the inflation numbers like the CPI. As the FT explains, we will get back doored by this if we don't pay attention to food and energy when making monetary policy decisions like rate cuts or increases.

These food riots could be that curve ball the Fed misses and gets socked with when import prices go through the roof. Bailing out Wall St. and flooding them with liquidity and cheap interest rates is becoming a very dangerous proposition.

When you play with fire you get burnt.

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