A Big Collection Plate; A Small Congregation

By: Michael Ashton | Thu, Jan 19, 2012
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Stocks rallied today (but no, trading was still somnambulant - volume is still some 250mm shares per day below last year's volume to date) by 1.1%, largely on news that the IMF is going to raise $500bln to help troubled Europe. This sort of crazy talk normally only comes from the smelly guy on the subway, who mutters in between such statements. But in this case, it was said with a straight face (although the original discussion of $1 trillion was apparently seen as too crazy to be bought). The IMF is going to raise this money from the world's economies, except Europe and the U.S. - the Obama Administration was quick to say that given our own rather messy finances, we would not be contributing to this passing of the hat.

So what that means is that half of the world's GDP (the U.S. and Europe represent about half) is hoping for a bailout from the other half. The other half, incidentally, includes various nations with which we are at war or have deep ideological differences with, or are basket cases themselves. Of 2010 world GDP of about $63 trillion, subtract the EU, the US, Japan, Iran, Venezuela, Pakistan, Iraq, Libya, and Syria, and we're down to $25.6 trillion. Let's then subtract any country with less than, say, $40bln in GDP because we assume the IMF isn't going to be calling Samoa to help out Europe. That takes us down to $24.5 trillion. Here are the only pan-trillion economies remaining in that group: China (5.9t), Brazil (2.1t), India (1.6t), Canada (1.6t), Russia (1.5t), Australia (1.2t), Mexico (1.0t), and South Korea (1.0t). Let's hear it for Canada and Australia, everyone!

Seriously, who is fooled by this gambit? We all know who has bankrolled global growth. If those bankrolls are now inwardly-directed, does anyone really believe China will commit 8% of GDP to help out her pals in Europe? And in case you haven't noticed, China has its own problems.

(Still, that wasn't the stupidest thing said today. It was at least intended to cheer us up, with humor perhaps, and it did pump stocks up 1.1%. But the stupidest comment came from the President himself, who apparently thinks paying unemployment insurance creates jobs. Quote: "However many jobs might be generated by a Keystone pipeline, they're going to be a lot fewer than the jobs that are created by extending the payroll tax cut and extending unemployment insurance." Yep.)

Now, there was some cheerful economic news today: the National Association of Home Builders sentiment index, which has been mired between 10 and 20 since late 2007, advanced to 25 today (see Chart, source Bloomberg). Now, this is a survey, but this looks like a legitimate improvement. Neutral on this index is 50, so it isn't all wine and song, but it's another one of those little indicators that things are getting slightly better. The question, of course, is whether any of this will stay on track when Europe finishes going off the tracks. And that seems unlikely.

National Association of Home Builders Market Index

Capacity Utilization also reached 78.1%, tying the highest level since June of 2008. Many years ago, economists thought that 80% was where the economy would experience capacity of scarcity that would push up inflation. Then Capacity Utilization remained above 80 almost uninterrupted between March of 1987 and December 2000, and while core inflation rose from 1987 to 1990...it then fell for 9 straight years. So another sacred economic cow was gored. Accordingly, while the rise in Capacity Utilization is a measure of good news for the economy, it doesn't really tell us anything about inflationary pressures.

Speaking of inflationary pressures, on Thursday along with Housing Starts (Consensus: 680k from 685k, but probably okay to expect something higher after the NAHB number), Initial Claims (seen unfortunately falling to 384k from 399k, thus killing some of those jobs Obama is talking about), and the Philly Fed (Consensus: unch at 10.3) we will get CPI.

The consensus for CPI is +0.1% on the headline number and +0.1% on core, bringing the year-on-year figures to +3.0% and +2.2%, respectively. I find the reasoning behind the low forecasts a little suspect; one primary excuse being given is that inflation should be low on "discounting." Well, folks, that's why we have seasonal adjustment factors. Discounting happens every December, at least in the U.S., so the seasonal factors expect something like a -0.2% decline in the non-seasonally-adjusted figures. There didn't seem to me to be an unusual level of discounting this holiday season. Indeed, my own anecdotal observation is that airfares (a mere 0.82% of CPI, however) were dramatically higher this Christmas than last. When the seasonal pattern is looking for declines, the anecdotes that matter are the ones that point out unusual increases. That is, if anecdotes matter at all, and they probably don't although they're fun to write about.

I do think that core inflation could well print another 0.2% "surprise" this month. Recall that last month, much was made about the ebbing of headline inflation despite the fact that core inflation surprised higher. But as I wrote last month in the article "The Inflation Trend Is Not Yet 'Tamed'", most of the consumption basket is still accelerating. While the Transportation subindex declined because of the drop in energy prices, what is more important is the breadth of the acceleration:

There has been a 5% fall in the year-on-year rate of inflation in 17.3% of the basket. That causes an 0.88% drag on the headline number. But the headline number only dropped from 3.569% to 3.394%, because every other major group accelerated.

The conundrum continues to be housing. The Housing subindex, which is about 42% of the CPI, rose over the last year at a 1.9% pace despite the still-high level of housing inventories. I expect this to continue this month, which could help produce another "surprise." Going forward, housing inflation should begin to ebb in the next quarter or two as those inventories and the renewed drip lower in owner-occupied housing that they have caused start to be felt in the rental markets. The chart below shows the Quarterly Survey of Apartment Market Conditions Market Tightness Index (that's a mouthful!) against the year-on-year rise in the Owner's Equivalent Rent component of CPI, lagged 4 quarters. Note that the QSAMCMTI just fell sharply, which leads me to expect a slowing in the housing component of core inflation fairly soon.

Quarterly Survey of Apartment Market Conditions Market Tightness Index

Unless CPI is a big high-side surprise, most of the data tomorrow should be cheerful. Equity investors ought to make hay while the sun shines, because what is rolling downhill from Europe is still pretty ugly. For now, though, we can imagine what might have happened to the economy in a world without the Euro straitjacket. Pressure should start to build on bond yields (higher).



Michael Ashton

Author: Michael Ashton

Michael Ashton, CFA

Michael Ashton

Michael Ashton is Managing Principal at Enduring Investments LLC, a specialty consulting and investment management boutique that offers focused inflation-market expertise. He may be contacted through that site. He is on Twitter at @inflation_guy

Prior to founding Enduring Investments, Mr. Ashton worked as a trader, strategist, and salesman during a 20-year Wall Street career that included tours of duty at Deutsche Bank, Bankers Trust, Barclays Capital, and J.P. Morgan.

Since 2003 he has played an integral role in developing the U.S. inflation derivatives markets and is widely viewed as a premier subject matter expert on inflation products and inflation trading. While at Barclays, he traded the first interbank U.S. CPI swaps. He was primarily responsible for the creation of the CPI Futures contract that the Chicago Mercantile Exchange listed in February 2004 and was the lead market maker for that contract. Mr. Ashton has written extensively about the use of inflation-indexed products for hedging real exposures, including papers and book chapters on "Inflation and Commodities," "The Real-Feel Inflation Rate," "Hedging Post-Retirement Medical Liabilities," and "Liability-Driven Investment For Individuals." He frequently speaks in front of professional and retail audiences, both large and small. He runs the Inflation-Indexed Investing Association.

For many years, Mr. Ashton has written frequent market commentary, sometimes for client distribution and more recently for wider public dissemination. Mr. Ashton received a Bachelor of Arts degree in Economics from Trinity University in 1990 and was awarded his CFA charter in 2001.

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