Can it rain and be sunny at the same time?

On Monday of this week, the inflation rate for the month of July was reported to be 0.8% or an annualized rate of 9.6%. This compares with an annualized rate in June of 7.2%. This would appear to be bad news because it means the price of goods and services are going up at a much higher rate than the Federal Reserve Board (Fed) would like to see (1.5% to 2.5%). In such a situation, you would expect to see the Fed increase their key interest rate. On Tuesday, the Fed met and left the key interest rate unchanged at 2%. This also means that the prime leading rate stays at 5%. The stock markets took this as good news, with a healthy advance in prices. The bond market took it as bad news with interest rates rising (and therefore the price of bonds declining). It would seem that, with the price of oil falling for the past week and the economy not looking its best, the Fed decided to gamble that prices will stabilize as oil prices are reduced. The lower oil prices could benefit food and transportation costs. This in turn could mean that inflation will be reduced. What we are seeing, in any event, is that the current Fed is more concerned with the economy than with inflation. Ed Mallon

Fearful Headlines

I have been noticing that the headlines used by the media during the past month seem to evoke fear. An example of some of today's headlines: "Oil Prices Plunge More Than $10 a Barrel!" "Fed Chief Details Woes in Markets, Housing, Jobs" "Bush: Troubled Financial System is Basically Sound" "Wholesale Prices Soar in June; Sales are Sluggish" Fear is what many Americans are feeling right now. They wonder if the financial system will be okay and more important, if they will be okay. We are driven by our emotions and the emotions of others around us. The more negative the news, the more negative and fearful we become. We are "news junkies" who need a constant infusion of the "latest news." The problem with all of this is that it does not give us perspective or context of the events happening around us. Most media personalities have little understanding of how the events fit into a broader pattern of economic and social forces. For example: What does oil plunging by $10 a barrel really mean? It likely means that some of the speculation in oil is giving way to more realistic pricing. If this trend continues inflation will be lowered and the value of the dollar strengthened. When the Fed chief details the "woes," do people realize that what he is saying is that the growth we are having is likely to be less than anticipated and that he still expects the economy to grow during 2008? When President Bush talks about the financial system, he is really saying that the government believes that the actions that are being taken by the Fed and Treasury will alleviate the current problems. Saying wholesale prices "soar" is simply saying that the "real inflation rate" which includes fuel and food, is rising at an annualized rate of 13.2 (1.1% in June multiplied by 12 months) as opposed to the "core inflation rate," which does not include the volatile fuel and food sectors, which is rising by an annualized rate of 2.4% (0.2% in June). Real people eat food and use energy! Until June when the Fed finally started to mention the real inflation rate, they had been consistently looking at the core rate of inflation and indicating that inflation was not a big problem. They now "get it" and will do what they need to do to contain real inflation. The inflation rate has meant a higher amount of income is going to essential expenses (food, fuel), leaving much less for other spending. I still believe we are going though a recession that is similar to the one we had in 1990, along with a bear market in stocks. The confluence of a bear market in stocks, a bear market in housing, and rising oil and food prices is unsettling. In the bigger picture, these events are setting the stage for the next new direction of the market. I am already seeing articles about new developments in "Green Technology." Keep oil up in price and, in the long term, the US will respond to become more self-reliant, stronger financially and better disciplined.

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!