Once again, the market focus has turned to the Fed. For many
months the official Fed policy has included an inflation target, an
annual rate of 2%. For many months I have written that inflation
will not matter until this level is in play. Suddenly, after a
single month of data approaching this range, some believe that
inflation is a threat.
There is plenty of economic data next week, and there could well
be a fresh theme from housing news. Despite this, I think that the
economic stories will all be interpreted through the lens of last
week's news. Expect a hair-trigger sensitivity to price increases
and a special focus on the PCE index release.
The media and punditry will engage in their favorite sport -
second-guessing the Fed!
Prior Theme Recap
some early news on Iraq before a mid-week shift to the Fed. That
was pretty accurate. The Fed news was the major event of the week.
On Friday we had the lowest volatility of the year, despite a
"quadruple witching" options expiration. Doug Short has
a regular feature capturing the week just past
with one of his terrific charts - the whole story in one
Naturally we would all like to know the direction of the market
in advance. Good luck with that! Second best is planning what to
look for and how to react. That is the purpose of considering
possible themes for the week ahead.
This Week's Theme
With plenty of economic data and little earnings news, expect
anyone with a microphone to ask interview subjects if the Fed is
"behind the curve." They will all oblige with an answer. Joe
Weisenthal always has the pulse of the financial community, and he
sees this as the
big story of the summer
. He highlights Fed Chair Yellen's answer that recent price
increases were "noise" and the skepticism from the Street.
With that in mind, let us start with some
There are many different measures of inflation. The Fed prefers
the Personal Consumption Expenditure Index (which will be updated
- Why? It better captures the impact on consumers than the CPI.
The two indexes frequently diverge because they are
constructed differently. While the weights in the CPI basket
change only every few years, the PCE's change each month,
better capturing consumers' tendency to shift from more
expensive commodities and outlets to cheaper ones. The CPI's
weights are also determined by what consumers say they spend,
whereas the PCE index is based on what they actually spend, or
what is spent on their behalf, such as the employer's portion
of health insurance, and what the federal government spends on
Medicare. As a result the CPI assigns much more weight to rent
and housing and much less to health care. PCE inflation over
time typically runs about 0.3% below CPI inflation, but the
current divergence, at 0.7%, is the largest in more than a
decade, according to Goldman Sachs.
- Some Fed participants might not agree. (See the
St. Louis Fed message
- The overall effect of PCE is a lower estimate of inflation.
(click to enlarge)
Is Fed policy too relaxed?
Here are the key perspectives:
- Inflation is already above the 2% target. There is less labor
slack than the Fed believes. Even if recent price increases are
temporary an economic rebound will rekindle the price pressure. (
Martin Feldstein op-ed
- Inflation is just about right, given the Fed target. (
Where do I stand? I am in the middle, predicting that
economic growth will stay moderate and that inflation will
remain modest (or vice-versa). Admittedly, the core CPI
inflation rate, on an annualized three-month basis, has been
rising rapidly recently, from 1.4% in February to 1.8% in March
to 2.2% in April to 2.8% in May.
Looking at the various components of the CPI shows that the
recent flare-up in the core inflation rate has been relatively
widespread. So there may be something to the reflation story,
but we aren't convinced just yet. In any event, we are feeling
more comfortable with our 2.5%-3.0% range for the 10-year
Treasury yield than we did on May 28 when the yield fell to the
most recent low of 2.4%.
- Inflation concerns are overblown. (Analysis from
- Janet Yellen is actually an inflation hawk, given the
economic forecast. (Fed Expert
- The US is in line with long-term inflation trends and is
certainly not like Argentina! (
Scott Grannis - good charts
Which of these viewpoints is correct
? As usual, I have some thoughts that I will share in the
conclusion. First, let us do our regular update of the last week's
news and data. Readers, especially those new to this series, will
benefit from reading the
Last Week's Data
Each week I break down events into good and bad. Often there is
"ugly" and on rare occasion something really good. My working
definition of "good" has two components:
- The news is market-friendly. Our personal policy preferences
are not relevant for this test. And especially - no
- It is better than expectations.
There was some encouraging news last week.
Homebuilder sentiment moved higher.
The reading of 49 beat expectations, but it is not quite
Investor sentiment has turned negative
- and that is a contrarian positive. The sentiment from the AAII
was in the "bad news" just last week, so it is making some quick
Bespoke has the story
and a beautiful chart showing the big shift:
were in line with expectations, but that confirmed positive
beat expectations, growing 0.6%. (See
calls it the "best economic news of the week." Most people do not
understand that a key economic issue is that the liquidity
provided by the Fed is not finding its way into the money supply.
Bank lending is a key, especially to small businesses. Here is
(click to enlarge)
St. Louis Financial Stress Index registered an all-time
. I have been highlighting this indicator for years. One of my
top researchers spent a summer analyzing the past data, helping
to develop a method for risk control (free paper available on
request). It is amazing how many investors prefer to be scared
witless (TM OldProf) rather than monitor this objective measure
of risk. Here is the
story and chart
from the St. Louis Fed.
The economic news included some negatives as well.
Oil and gasoline prices
moved higher. New Deal Democrat's
excellent weekly summary
of high-frequency indicators highlights this move as the most
important feature of his report. He writes as follows:
The oil price spike due to Iraq continued this week. This
will bleed through to gas at the pump in the next few weeks.
The Oil choke collar is re-engaging, and if Iraq falls apart,
or if its oil exports are disrupted, there will be economic
There is no denying the increase in energy prices, but there
are different interpretations of the effects.
Michael Santoli suggests
, "Yet better average gas mileage, higher wages and a dramatic
decline in miles driven since 2008 means a further climb in gas
prices probably wouldn't pinch consumers noticeably unless it
reached the new "pain point" of about $4.25 a gallon."
Prof. James Hamilton
, our go-to expert on energy and the economy, reviews his
research and also includes a helpful calculator showing the
relationship between oil and gasoline prices. If you pick $4.25
as your "pain point" that implies about $137/barrel for Brent
crude. $4.00 per gallon is about $10/barrel lower.
Higher energy prices are like a tax on consumers with no
corresponding payoff. There is also no specific trigger point.
Not everyone will react in the same way of course, truly a case
Confidence in Congress
hits a new low. (Some might see this as "good news" since it
suggests possible change!) It is not quite that easy. People
typically blame the institution of Congress while re-electing
their own representative. Viewed from the other direction, making
the right decision requires some support and compromise. Gridlock
has not worked very well. Here is the recent chart (
is threatening refineries. This is the step that would really
and the world economy.
This Canadian story
emphasizes the effects on consumers. GEI highlights a
explaining ISIS, the Sunni group behind the insurgency. Do you
have 90 seconds to spare?
Americans go further into debt
to pay the basics. (
, but compare above and note the difference in borrowers). The
credit card companies can borrow at near-zero rates, which helps
to reduce lending standards. While we could have paid cash for
Mrs. OldProf's new wheels, why not finance at zero percent for
five years when that beats the cash incentive? These measures of
debt are challenging to interpret.
Sea container counts
are lower. It is the second consecutive month. Steven Hansen,
writing at Global Economic Intersection has the
with excellent data comparisons and charts. We also wish to
congratulate GEI on their well-deserved
surge in the blog rankings
. As an early contributor, friend, and occasional critic
(constructive I hope), I am delighted to see the success of my
Building permits and housing starts
were weak - very weak. This happened in spite of the rebound in
builder sentiment. Bespoke has a great overall summary with
tables and charts. Calculated Risk, our featured source on
housing matters, still
believes the story will improve
because of year-over-year comparisons and general growth. See
, but here is one helpful table:
Cheating. Here are three examples in recent news.
The World Cup: The New Yorker's
Cheating the Beautiful Game
How To Catch A Chess Cheater: Ken Regan Finds Moves
Out Of Mind
Captain of the US Senior team
on how they exposed the German pair of "coughing doctors" in the
World Championship Final in Bali. (Appeal pending).
These are not the only examples from sports and games, of
course. You could also make up a list from politics, business, and
finance. In the examples I suggest, the violations are all the
result of studying records after the fact.
The Silver Bullet
I occasionally give the Silver Bullet award to someone who takes
up an unpopular or thankless cause, doing the real work to
demonstrate the facts. Think of The Lone Ranger. No award this
week. Nominations are always welcome!
Whether a trader or an investor, you need to understand risk. I
monitor many quantitative reports and highlight the best methods in
this weekly update. For more information on each source,
Recent Expert Commentary on Recession Odds and Market
: A variety of strong quantitative indicators for both economic and
Bob Dieli does a
(subscription required) after the employment report and also a
monthly overview analysis. He follows many concurrent indicators to
supplement our featured "C Score." One of his conclusions is
whether a month is "recession eligible." His analysis shows that
none of the next nine months could qualify. I respect this because
Bob (whose career has been with banks and private clients) has been
far more accurate than the high-profile TV pundits.
Updates his unemployment rate recession
, confirming that there is no recession signal.
Georg's BCI index
also shows no recession in sight. For those interested in hedging
their large-cap exposure, Georg has
unveiled a new system
: An update of the regular ECRI analysis with a good history,
commentary, detailed analysis and charts. If you are still
listening to the ECRI (2 ½ years after their recession call), you
should be reading this carefully. Doug includes the most recent
ECRI discussion, which has been consistently bearish, including the
blown call on the recession.
Doug also has the
best continuing update
of the most important factors to the NBER when they analyze
recessions. This week he updated the retail sales indicator,
illustrating the recent weakness:
Where is the US economy growing?
has a state-by-state breakdown. Perspectives might differ
(click to enlarge)
The Week Ahead
We have a very big week for economic news and data.
The "A List" includes the following:
- Core PCE Prices (Th). Given the buzz over CPI and Yellen, the
Fed's favorite indicator makes the "A list."
- New home sales ((
)). May data. Housing remains a big question mark for the rebound
in the US economy.
- Initial jobless claims (Th). Best concurrent read on
- Personal income and spending (Th). Important growth
- Consumer confidence. The Conference Board version informs
about employment and spending in a concurrent fashion.
- Michigan sentiment ((
)). Similar to the Conference Board in overall results, but uses
a continuing panel as part of the survey.
The "B List" includes the following:
- Existing home sales ((
)). A good economic read, but less significant for growth than
new home sales.
- Durable goods orders (W). A key coincident indicator.
- Case-Shiller home prices. This always gets attention, despite
the lagging and narrow nature of the index.
- Q1 GDP (W). This is normally not interesting since in market
terms it is ancient history. This week it will be newsworthy
because of the expected revisions. Some believe that Q1 will go
into the books with a 2% decline.
In the week after the FOMC meeting we can expect plenty of
FedSpeak. Several appearances are on the calendar.
While the financial markets have adjusted to the current Iraq
story, there is plenty of attention to any breaking news.
How to Use the Weekly Data Updates
In the WTWA series I try to share what I am thinking as I
prepare for the coming week. I write each post as if I were
speaking directly to one of my clients. Each client is different,
so I have five different programs ranging from very conservative
bond ladders to very aggressive trading programs. It is not a "one
size fits all" approach.
To get the maximum benefit from my updates you need to have a
self-assessment of your objectives. Are you most interested in
preserving wealth? Or like most of us, do you still need to create
wealth? How much risk is right for your temperament and
My weekly insights often suggest a different course of action
depending upon your objectives and time frames. They also
accurately describe what I am doing in the programs I manage.
Insight for Traders
Felix grew a bit more cautious last week - fewer positive
sectors, lower median score, and greater uncertainty. Our
three-week forecast is still bullish, but it is a closer call. This
week we were fully invested in three of the top sectors for our
You can sign up for Felix's weekly ratings updates via email to
etf at newarc dot com.
Here is some great advice for traders
from Ryan Detrick
, one of our favorite sources. He lists ten things he has learned
in his decade of trading experience. The list reflects my own
experience and also the behavior of the best traders I know. It is
difficult to pick a favorite, so you should read them all. Forced
to pick one, I choose "There's no wrong way to make money…..If you
are lucky enough to find one thing you are good at, do it and
Insight for Investors
I review the themes here each week and refresh when needed. For
investors, as we would expect, the key ideas may stay on the list
longer than the updates for traders. The current "actionable
investment advice" is
The market still did not provide much opportunity for fresh
buys. The gentle upward action is fine for long-term investors and
excellent for those trying out our Enhanced Yield approach.
Here are some key themes and the best investment posts we saw
Beware of "liquid alternative" funds. Jason Zweig's must-read
column, The Intelligent Investor, covers this story in the context
of a recently failed fund. These investments might be a good fit,
but be careful!
Liquid-alternative funds generally offer the prospect of doing
well when U.S. stocks do poorly. That hope comes at a price,
however: Such funds, which tend to charge high fees, typically do
poorly when U.S. stocks do well. Investors who don't understand
this link will inevitably be sorry.
Tadas Viskanta, who writes Abnormal Returns (which is
universally used to keep track of important events in the financial
blogosphere) is taking his annual brief and well-deserved vacation.
He solicits some comments on important questions, and publishes the
results during his week off. These are all great reads, full of
links and ideas. Here is the
advice for novice investors
(which has value even for those with experience). And here are
suggestions about what to read
. Only Tadas could create so much content while taking time
Bond funds are a continuing source of risk. Is there really
consideration of an "exit fee"? I rather doubt it, and also
question whether it would work. The very idea of this discussion is
something of a warning. (
). People expect these investments to represent the safe part of
their portfolio. If we really do get the inflation that the Fed is
seeking, interest rates will rise and bond prices will fall.
If you are worried about possible market declines, you have
plenty of company. This is one of the problems where we can help.
It is possible to get reasonable returns while controlling risk.
You can get our report package with a simple email request to main
at newarc dot com. Also check out our recent recommendations in our
new investor resource page
- a starting point for the long-term investor. (Comments and
suggestions welcome. I am trying to be helpful and I love and use
Writing about inflation is a thankless task. Readers begin by
thinking they know all of the answers. We all shop, right? It is
the most popular subject for bamboozling people, since it is easy
to find examples of rapidly rising prices. It is by far the most
deceptive trap for those who might confuse politics with
You have a simple choice:
- You can reinforce your beliefs and take joy in how stupid our
leaders are. You and your favorite blogger, pundit, Congressional
candidate, etc. have all of the answers. You are all smarter than
the isolated, ivory-tower academics at the Fed. Please note that
this was the trap that ensnared leading experts and wise
observers like John Hussman and the ECRI - just to mention two of
the most prominent examples who have had disastrous results over
the last few years.
- You can accept the fact that the Fed has the power to set
policy. It is wiser and more profitable to understand what they
are doing and just
go with the flow
. You can grumble with your friends at the bar, vote your
conscience at elections, and still profit from your
I have been extremely accurate in my Fed forecasts, but I am not
claiming any prizes. It has not been difficult. I simply read
information carefully and understand that it is a committee at
work. Here are the key takeaways. You will disagree. You will hate
them all. Keep reminding yourself that even if you are right and
Yellen is wrong, you will lose on your investments. The Fed has the
power. Figure out how to use the knowledge to your advantage.
- The Fed is attempting to increase inflation. They seek 2% on
the PCE index. This runs about 0.5% cooler than the CPI.
- The Fed does not measure inflation through commodity
- The Fed believes that 2% is price stability. They think that
. They do not subscribe to ShadowStats (and neither do any of the
people they respect). They also see a touch of inflation as
easier to fix than deflation. Their bias is toward stimulus.
- The Fed will tolerate as much as 2.5% inflation (on the PCE
index) for a time.
- The Fed has a dual mandate - inflation and employment. It
does not protect savers or emerging markets. Learn to live with
it and ignore pundits who think this is important.
- The Fed sees food and energy as noisy components of inflation
- wild movements that do not relate to the dual mandate. If food
prices are up because of a drought or disease in hog herds, how
could this be controlled by raising interest rates? Middle East
geopolitics and oil? Same question. These price changes are
certainly real, but they are volatile and not relevant for
- The Fed does not shift policy based upon small monthly
changes in data. Longer trends are demanded.
The conclusion is that Fed policy is on a relatively stable
course, but data dependent. The market does not like this, since
the preference is for certainty.
If you think about it, even just a little, you can see an
obvious edge for investors. You need only accept the reality of the
obvious course of policy and ignore the pundits. The Fed has always
succeeded in creating inflation - eventually. It will happen again,
but given the overall economic weakness it is taking longer. My
current guess is late in 2016 or so. Meanwhile, there are some
profitable investments to enjoy.
Monitor data, not pundits.
The author has no positions in any stocks mentioned, and no plans
to initiate any positions within the next 72 hours. The author
wrote this article themselves, and it expresses their own opinions.
The author is not receiving compensation for it. The author has no
business relationship with any company whose stock is mentioned in
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