FED changes

Yesterday, June 25th the Federal Reserve Board (FED) made a change. The change was that there was no change. They kept a key Federal Funds lending rate (the interest rate) at 2.00%! This was an expected decision by the investment markets around the world. It did confirm however that the FED is concerned with “REAL” inflation and is not talking about the “Core Inflation Rate” as they did at prior sessions. Since the Clinton administration decided to mess around with how the inflation rate is calculated (as well as the calculation of unemployment) reality has taken a holiday! When you hear about the inflation rate you are usually hearing about the “Core Inflation Rate.” What is the “Core Inflation Rate?” Let me put it this way: someone asks me what I had for dinner last night and I tell them “A plate, a knife, fork, spoon and napkin.” No food? Food doesn’t count in the “Core Inflation Rate”. How did you get to work today? By car. How did the car move you from home to work? On wheels. Energy doesn’t count in the “Core Inflation Rate.” How are cost of living adjustments that are made by the US Government on things such as Social Security determined? Of course, using the “Core Inflation Rate.” Food and energy costs have gone up substantially in the past six months. In addition, the increased cost of food and energy are rippling through other products we buy and services we use, such as plastic products and restaurant price increases. The FED is in a dilemma! On one hand the economy appears to be in a recession while on the other hand inflation is a problem. To curb inflation you raise the interest rate. To help the economy you lower the interest rate. The current answer by the FED was to do nothing! In March of this year we moved some investment money into investment grade bonds and into high yield bonds. At the time we had seen the investment grade bond interest rates go from about 4.75% in October to 6% at the beginning of March. A bigger change had occurred with the high yield interest rates going from about 7.25% to 12%. Since that time the investment grade rates and high yield rates had been going down to 5.8% and 10.5% respectively. I told some of you that I was very cautious about how much money we should place into these investments because I was worried about inflation. I am very glad I was cautious. As of today the investment grade interest rate is over 6.20% and the high yield rate is now up over 11.40%. High interest rates are not good for business and therefore not good for stocks. Based on the above I believe that stocks will go down more and longer term interest rates will continue upward until the FED begins to raise their Federal Fund interest rate and show that they are serious about fighting inflation. At some point, when the interest rates get high enough, longer term interest rates will be a real buy!

What a Week

What a Week! This past week saw the Dow go down 3.39%, the S&P down 2.83%. This was in part a response to economic events that were reported during and at the end of the week. On Tuesday, Standard & Poor’s/Case –Schiller’s national home price index fell 14.1% in the first quarter. On Friday, the government announced that the unemployment rate rose by an unexpected 0.5% to 5.5%. Oil futures hit $138.54 per barrel on Friday, and an investment banking firm on Wall Street said they thought it could hit $150 by summer. A consensus was building that the US economy is either in or going into a recession. The outlook for Europe is not good either. Wow! What does all of this mean? Having money in cash or cash equivalents certainly seems to make sense. Having money in investment-grade and high-yield corporate and municipal bonds paying interest seems to make sense. With the dollar on the decline, even international investments make some sense. For example: even with the worst earthquake in 32 years China’s passenger-car sales grew 16% last month. Global growth seems to be unabated. How about commodities? Commodities tend to move in the opposite direction of the dollar. This would include oil, gold, silver, etc. The commodity markets indicate that there is widespread speculation occurring presently. The head of the Federal Reserve, Ben Bernanke, is talking about a strengthening dollar. This could mean the federal government is about to get serious about reversing the dollar’s direction. Such a move would likely not be good for commodities. Could the bubble burst and the price of oil tumble? Some say world demand is such that, when coupled with flat output, this could not happen. I don’t believe it! I lived through the period when the Hunt Brothers tried to corner the market on silver. From $1.95/oz. in 1973, silver skyrocketed to $54/oz. Ordinary people were buying silver with the expectation that it would just keep rising. Bang! Down went silver prices. From 1980 through 1987, silver prices dropped to about $10/oz. Today silver is priced at about $17/oz. (More recently, Americans were sure that real estate would just keep on rising! Ugh!) Is the same now true with oil? Ed’s pendulum theory says: “Every investment market swings from being underpriced, relative to the norm, to being overpriced!” In this process it is possible for an investment market to establish a new “norm” but it will be within the range of over- and under-pricing. This is not to say that an individual investment within that market will outperform or underperform. But, the overall market, such as the market for oil, must go through this process. With commodities like oil, it is often thought that there is a finite amount of something and therefore its price can go up with no end in sight. In fact, it appears that when a particular commodity becomes overpriced, a new substitute will either be found or it will become cost-efficient to utilize a competing commodity. The question in my head now is: “Are we ready to become Green as a society and invent new ways of living?” Ed Mallon