Hurricane Season - the Ace in the Hole for the Market?

While hurricanes pose huge risks for cities and individual safety, they may provide another reason for commodities to rise, and inflation to arrive sooner than most analysts think. The Atlantic basin, while quiet, is warming up, and looks like it will bring its share of storms in the coming months. With the Gulf of Mexico already in the 80s (Fahrenheit), it will become a concern (as it does every late summer) to funnel major hurricanes into the major refineries and the major U.S. oilpatch. This year, this will almost certainly bring with it $80 oil, increasing prices for many commodities, and potentially, another reason for the market to move up.

U.S. GDP - A Primer for the Second Half

Last week, second quarter GDP numbers came in with a contraction of 1.0%, better than the expected decline of 1.5%. While nothing to cheer at, the pace of contraction has now been pared, and we finally appear to be stepping out of a technical recession, although increasing unemployment will make the recession feel a lot longer.

The topic on most economists' minds is whether the recession is officially over. I think that we are likely to see a very steep recovery in GDP, contrary to most economists. The reason I say this is from the interesting news stories we have seen in the last week or so.

For one thing, inventories in most sectors are already at very low numbers, and big-ticket items like houses and cars are now being purchased hand over fist thanks to the current and prior U.S. administrations' willingness to burn cash like a California wildfire. In four days, the entire $1b "Cash for Clunkers" budget was used. Given the average car costs about $28,000 and the program provided $4,500 in cashback for trade-ins, this means about $6.2b in vehicles were sold (about 222k cars) - in four days! Last year, the US sold just over 16m cars and trucks, without any government sponsorship. The auto manufacturers have already reduced their inventories significantly, temporarily and permanently shutting down plants across North America.

When inventory is sold at such extremely high rates, especially when the forecast is for government programs to last 12 weeks, it makes me feel that the American consumer is again willing to spend money more quickly than Wall Street thinks. The pent-up demand will push inventories to ridiculously low levels in these big-ticket items, meaning higher prices, and a push back to inventory builds, and higher employment in the near-term (6-9 months, rather than 18-24 months). While the US household has been beaten and bruised, it is a resiliant entity, prepared to buy, buy and buy some more.

Unlike the recovery of 1982 (when we had "V" like recovery - like I anticipate this time around), we have Fed sponsorship in the recovery, with trillions of dollars sloshing through the economy, and we are likely seeing the first signs of acceleration of this moneyflow through the market place (with the highest credit worthy consumers snatching up vehicles and homes). This makes me a believer that we will see massive worldwide growth, a return to increasing commodity prices, and a more permanence to the inflationary conditions plaguing North America in the 2005-2008 period. Commodity capital projects have been halted or delayed and developing countries are showing signs of growth and demand, making me convinced that we will see demand overtake production very quickly, and we will need to wait for capital projects to end before the inflationary pressures reduce to more normalized levels.

Thoughts on the state of the World Economy

I have said that my appetite for purchasing equities has increased in recent months, and I continue to look for opportunities to do so. That said, I have had some interesting thoughts about the world markets that I'd like to share.

The United States vs. China

I am deeply worried about how the overall world economy can grow in the future without some decoupling of the Chinese currency from the U.S. currency. Only a year ago, the U.S. government was begging the Chinese to remove their peg of the U.S. dollar (by selling the dollars/Treasuries they currently own - in the trillions of dollars) - and allow the RMB (yuan) to inflate from its artificially low USD peg. Twelve months later, I'm sure the Chinese are wondering why they didn't move to further de-peg their RMB. The USD has been rapidly strengthening against virtually all major currencies, save for the yen, and it has caused quite a Catch-22 for the US and China. Should the Chinese sell those treasuries and dollars to the open market, surely the appetite for US dollars will appreciably fall, and the dollar could collapse under the weight of the US's very own printing press. This could have one of two effects, one desirable and one undesirable.

If this were to occur, we may worldwide be lucky enough to see a decline in the USD - and the return of inflation, the growth engine of the world. A stronger RMB is in the cards in the next 5-10 years anyways. The Chinese will become a consuming nation of finished goods rather than a supplier of them, and will need to offload its peg to be able to consume more using a higher valued currency. Why not now?

Well, the flip side of the question is the answer to that question. The Chinese economy could potentially trade places with the U.S. by selling its treasuries. By strengthening the RMB at this time, it loses its global position of cheapest mass producer, which is the engine it has now. If it doesn't sell the USD and treasuries, it is already losing that position with other global players like the EU.

The European Union - is the model sustainable

The EU continues to lower its interest rate, to stave off huge problems for behemoths like Spain (the housing bubble) and Germany (which has seen its share of problems with the likes of VW). This brings me back to my old question - will the Euro survive? By creating the Euro, Germany and other large European countries placed their confidence in the hands of emerging economies like Slovakia and Slovenia. The dynamics in each country can conflict with each other, and result in movements by the European Central Bank that may run contrary to the needs of individual member states that have adopted the Euro. In late-2008 Germany was already handing hundreds of billions of Euros to its banks in an effort to shore up its banks, while the ECB was still being implored by the world to lower its rates. The ECB seems to be very much behind the curve now, and is desperately trying to catch up with lower rates that the US has already applied. I feel that the EU is showing tremendous cracks under the pressure of its model. While free trade is always an ideal, countries giving so much control of their economic viability to a central bank certainly is not. How this affects trade with China and the U.S. is still emerging.


This is the primary reason I love macro-economics - there are millions of issues at play (with a few Black Swans that will emerge along the way), and it takes market makers months to digest a slice of that information to make decisions. We are participants of the most exciting film (I just hope most of us can leave the theater with our shirts) the world has seen in some time. This is the essence of globalization: we will see more volatility, more Black Swans and more currency blowups.

Thinking Long-Term: Secular Bear Markets

Fear has gripped world markets, world governments, and pretty much everybody around the world. This economic disaster is the result of the excesses that the world enjoyed throughout the 80s and 90s. We are now paying for the leverage and lending bubble that developed, as people tried to keep the party going. Now, everyone's scared that the world will end up in a long-drawn recession, or much, much worse (I'm just as worried as everyone else). If you've been reading this blog, you can see that I hedged myself against a market meltdown, which we experienced over the last 6 weeks. Contrary to most, I'm feeling much better now than I did then.

I have been a proponent of the "Dow Theory". Essentially what this stipulates is that the market goes through cyclical ups and downs over the short-term, and secular ups and downs over the long-term. These cyclical movements can result in 3 month to 6 year trend movements in the markets, whereas longer term secular movements can result in 7 to 25 year longer term trends. In a secular bear market, the markets can move in cyclical bear or bull markets, but ultimately the market cannot break its former highs. Make no mistake of it, we are in a secular bear market, and have been in one since the dot-com crash in 2001. The S&P 500, the 500 companies deemed to represent the U.S. economy best, has not been able to break the 1,580 to 1,600 mark for the last 8 years. Over this time, the world economies have been growing dramatically, but as a result of huge P/E ratios and expectations in the late 90s, early 2000 period, we are going through a period of consolidation in the marketplace. Ultimately, in general, historical P/E ratios reach the single digits before the market can once again proceed forward into a new secular bull market.

In essence, the businesses are catching up to the lofty expectations in the 90s. It's as though the market was the driver in a very serious car accident. While the accident only takes a moment, it takes years to resusitate, rehabilitate, restrengthen and renew the driver and his/her health and confidence before we can move forward. However, ultimately, before the renewal of the driver's confidence, we know that their health is no longer in question. The market will get project this health much sooner than we as individuals get the confidence to fully invest again. We must be willing to step in front of the train with the hopes that it will stop before it hits us smack in the face (figuratively-speaking of course).

I'm not calling a bottom, nor am I saying I have closed all my hedged positions (buying ETF's that move inverse to the markets). What I am saying is this: even in the 1930s, the bottom happened within 3 years of the start of the Depression. If you have a longer-term outlook, you have to be compelled into investing somewhat into the markets. I have been slowly closing hedges, and buying equities. Mostly, this equity is in low debt stocks or large-capital stocks that will continue to sell goods the world needs.

Within the rubble of any disaster lies the tools, lessons and catalysts for the next great growth period. In this market, there are companies that will become the next great stocks to hold as the market starts to move upwards again.