How Gold Is Mined: Jun 8, 2013

Saturday, June 8, 2013

KOTOK: This Low Inflation Environment Is Fantastic For Stocks

Inflation is not on the radar anymore. We do hear occasional comments from central bankers who warn about future inflation arising from QE. We also recall a few statements in the media along the lines of, "They're printing all this money, we're going to have huge inflation, and interest rates are going to shoot up."

We have been on the low-inflation side of that debate for years. We have supported the argument that there is a huge overhang of surplus capacity in the global labor force and that inflation is not a problem when labor income is flat, falling, or not rising robustly. This coincides with a wounded credit multiplier and a damaged financial credit system, conditions that have existed for the last five years. They are gradually improving, but only gradually. They are conditions that cause deflationary pressures.

Will we have deflation? We are not certain. The forces at work globally that could bring on deflation are being blunted by the huge quantitative easing (QE) being undertaken by most major central banks.

Let's take a quick look at the US. All important measures of inflation in the US are on downward trends. Many thanks to Credit Suisse's Neal Soss and Jay Feldman for a recap of the data in their research note of May 17. They report Core CPI, Cleveland Fed Median CPI, Cleveland Fed Trimmed Mean CPI, Core PCE, and Dallas Fed Trimmed Mean PCE. All are trending downward, as measured on a year-over-year basis, and those trends are accelerating. Commodities are also on downward price trends. So are the more esoteric inflation measures like market-based indices and chained indices.

In the case of the Core PCE, which is believed to be the Federal Reserve's preferred measure, the rate of inflation measured year-over-year is approaching one percent. Remember that the Fed's threshold for any change in monetary policy is two percent. And Fed communications have suggested that a rate of 2.5 percent would be the threshold for any action taken to alter QE for the purpose of improving the employment statistics. So we are a full point and half away from that threshold, and the trend is in the opposite direction.

The Fed's stated unemployment threshold is 6.5 percent on the traditional headline unemployment rate (U-3). The Fed has also talked about other elements in the employment statistics, suggesting that the U-3 unemployment rate is not the only target measure for restoring the US to a more robust recovery. The charts and graphs that we have posted on our website and released in speeches present the employment statistics in a variety of ways that may be useful.

Other measures, such as the U-6 broad-based unemployment rate, Beveridge Curve analysis, and the disaggregation of employment data, all point to a very large underutilized labor force in the US. The same seems to be true for most of the rest of the world.

Our conclusion is that inflation is not a problem now and is not likely to become a problem soon. In fact, if certain indicators of inflation continue to head downward, they could trigger a reaction by the Fed because the risk of deflation will be perceived to be rising.

Is deflation a threat today? The answer seems to be no. More likely, we are in a period in which the rate of inflation will be too low to be a problem and will gradually turn higher over several years as additional stimulative policies unfold worldwide.

Meanwhile, low inflation is a very healthy environment for the stock market. It means that inflation distortions in reports of earnings are nearly nonexistent. That implies that the quality of earnings reports is very high, since they do not contain the distortions that occur in accounting systems when inflation is high.

Higher-quality earnings justify higher price/earnings multiples and higher stock prices. There is a consistent linkage between very low inflation and very strong asset pricing. This is particularly so when interest rates are very low and likely to stay low for a very long time.

We remain bullish. Inflation statistics support that outlook. They also support a gradual change in the outlook for bonds. Eventually, bond yields will be higher, maybe much higher, but the process is a gradual one. That means some tactical hedging in bond portfolios is appropriate. Panic selling of bonds is not.

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Investors Are Borrowing Like Crazy To Leverage Up Their Stock Market Bets

Doug Short is the vice president of research at Advisor Perspectives.

Note from dshort: One of my economic correspondents, James Ross, called my attention to the fact that the NYSE has released new data for margin debt, now available through April. I've updated the charts in this commentary to include the new numbers.

The New York Stock Exchange publishes end-of-month data for margin debt on the NYXdata website, where we can also find historical data back to 1959. Let's examine the numbers and study the relationship between margin debt and the market, using the S&P 500 as the surrogate for the latter.

The first chart shows the two series in real terms — adjusted for inflation to today's dollar using the Consumer Price Index as the deflator. I picked 1995 as an arbitrary start date. We were well into the Boomer Bull Market that began in 1982 and approaching the start of the Tech Bubble that shaped investor sentiment during the second half of the decade. The astonishing surge in leverage in late 1999 peaked in March 2000, the same month that the S&P 500 hit its real all-time high. A similar surge began in 2006, peaking in July, 2007, three months before the market peak.

The next chart shows the percentage growth of the two data series from the same 1995 starting date, again based on real (inflation-adjusted) data. Margin debt grew at a rate comparable to the market from 1995 to late summer of 2000 before soaring into the stratosphere. The two synchronized in their rate of contraction in early 2001. But with recovery after the Tech Crash, margin debt gradually returned to a growth rate closer to its former self in the second half of the 1990s rather than the more restrained real growth of the S&P 500. But by September of 2006, margin again went ballistic. It finally peaked in the summer of 2007, about three months before the market.

After the market low of 2009, margin debt again went on a tear until the contraction in late spring of 2010. The summer doldrums promptly ended when Chairman Bernanke hinted of more quantitative easing in his August, 2010 Jackson Hole speech. The appetite for margin instantly returned, and the Fed has periodically increased the easing.

Unfortunately, the NYSE margin debt data is a few weeks old when it is published. In nominal terms, margin debt at the end of April 2013, the latest available data, has sharply increased since the middle of last year and is now approaching levels associated with market peaks.

Lance Roberts, General Partner & CEO of Streettalk Advisors, analyzes margin debt in the larger context that includes free cash accounts and credit balances in margin accounts. Essentially, he calculates the Credit Balance as the sum of Free Credit Cash Accounts and Credit Balances in Margin Accounts minus Margin Debt. The chart below illustrates the mathematics of Credit Balance with an overlay of the S&P 500. Note that the chart below is based on nominal data, not adjusted for inflation.

As I pointed out above, the NYSE margin debt data is a several weeks old when it is published. Thus, even though it may in theory be a leading indicator, a major shift in margin debt isn't be immediately evident. Nevertheless, we see that the troughs in the monthly net credit balance preceded peaks in the monthly S&P 500 closes by six months in 2000 and four months in 2007. The most recent S&P 500 correction greater than 10% was the 19.39% selloff in 2011 from April 29th to October 3rd. Investor Credit hit a negative extreme in March 2011.

There are too few peak/trough episodes in in this overlay series to take the latest credit-balance trough as a definitive warning for U.S. equities. But we'll want to keep an eye on this metric over the next few months.

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3 Ways to Cash In on the Chemical Industry’s Building Binge

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STOCKS CLOSE DOWN FOR 3RD STRAIGHT DAY: Here's What You Need To Know (DIA, SPY, QQQ)

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Stocks rallied well off of their lows. Still, they ended in the red for the third day in a row.

First the scoreboard:

Dow: 15,303, +8.6 pts, +0.0%
S&P 500: 1,649, -0.9 pts, -0.0%
NASDAQ: 3,459, -0.2 pts, -0.0%

And now the top stories:

This morning started with a durable goods orders report that blew past expectations. In April, total orders jumped by 3.3%, beating expectations for a 1.5% gain. This was largely driven by a rebound in commercial aircraft orders. However, nondefense capital goods orders excluding aircraft — or core capex — climbed by 1.3%, crushing expectations for a modest 0.5% increase. Core capex is a key measure of business investment.This was welcome news, especially in the wake of a lot of disappointing data earlier this month. "Stronger core durable goods orders suggest that the order pipeline that will drive future investment and inventory growth continues to improve, helping to fuel the transition out of the current soft patch," wrote TD Securities' Gennadiy Goldberg.But the report wasn't all good news. "To calculate GDP, economists look at shipments for non-defense capital good and exclude aircraft," noted Brown Brothers Harriman's Marc Chandler. "This component fell 1.5% after a 0.5% gain in March."Don't Miss: The Incredible Story Of America's Boom, Crash, And Comeback In 99 Maps >

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