This note was originally published
at 8am on December 28, 2010.
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“By a continuing process of inflation, government can confiscate, secretly and unobserved, an important part of the wealth of their citizens.”
-John Maynard Keynes
A Google search for quotes related to “inflation” produces quotes from Keynes in the first 10 spots. While his radical idea that government should spend money it doesn’t have may have saved us from the brink of a financial collapse, he might not have agreed with QG (Quantitative Guessing) and the impact it is having on global inflation.
The week in between two holidays is challenging on many fronts - personally and professionally. Typically, there is little incremental macro data in the U.S. because politicians take time off for the holidays rather than trying to force issues when there is no audience. In addition, most “big money” institutions are not going to make any big bets when there is no liquidity.
We headed into the holiday lull with a bullish sentiment, an overbought market and MACRO factors that continue to keep us on the bearish side of a tightly-wound, high-risk environment. Yesterday, on a stealth day for MACRO news, the VIX shot up 7.29%, putting a two-day move at 13.89% (but still down 18.5% YTD).
The world is interconnected and this year’s “tweener week” is filled with interesting global macro data points, especially after China used the holiday weekend to hike interest rates in an attempt to ward off mounting inflation.
The news/rumors this week do not stop with China! After the first of the year, Taiwan and South Korea will also be raising rates to battle domestic inflation. How ironic that the region of the world (Asia) that is the hot bed for “deflation” for the balance of the planet is fighting a battle against domestic inflation. If slowing growth in the emerging markets is not on your list of 10 surprises for 1Q11, it should be.
Don’t take my word for it; the Chinese equity market is now down 9 of the last 10 days, declining 1.74% last night (down over 3% at one point). The Chinese don’t mince words about where they think things are headed. Overnight China’s Premier Wen Jiabao said measures to curb the country’s property market “weren’t well implemented” and reiterated his goal for home prices to return to a “reasonable level” during his term that ends in 2012.
This is the killer statement by Wen Jiabao: “We introduced about 15 measures this year but it appears that they were not well-implemented….I believe that after some time, the home market will return to a reasonable level with our efforts.”
If China did not get it right in 2010 (even though the Shanghai Composite is down 16.6% YTD) and they implement measures to curb property prices more effectively in 2011 and demand begins to slow as a result of a heightening cycle, we could see Industrials (XLI) and Metals (XLB) quickly come under pressure. With the Chinese market as a leading indicator of growth and the market trading down 3.1% over the past month, those sectors and commodities with the biggest leverage to Chinese demand are likely headed lower, despite recent moves higher.
Over the past month:
(1) The S&P 500 is up 5.1%
(2) The XLB is up 9.6%
(3) The XLE is up 7.5%
(4) The XLI is up 6.7%
(5) The CRB is up 9.3%
(6) Copper is up 13.8%
In light of Wen Jiabao’s statement, it is interesting to note that the best performing sectors year-to-date are also those with the most leverage to Chinese demand. The four best performing sectors are:
(1) Consumer Discretionary (XLY up 26.03% YTD)
(2) Industrials (XLI up 25.51% YTD)
(3) Energy (XLE up 17.82% YTD)
(4) Materials (XLB up 15.79% YTD)
While most Asian central bankers seem to see that there is an inflation problem, in the USA we still cannot see it, despite a number of “real life” examples of real inflation hitting the U.S. consumer hard. Yes, we are going to hammer home a key theme in 2011: Jobless Stagflation (inflation accelerating, growth decelerating) is here to stay.
Of course, the components of any inflation index are up for debate. For instance, the government and most people that disagree with our view on inflation prefer to exclude staple, non-discretionary aspects of consumer spending such as food and energy from the calculation. One item I hope we can all agree to include is healthcare costs.
According to the Commonwealth Fund (a non-profit fund), U.S. health-insurance costs are rising more quickly than the ability of U.S. families to pay for it. They cited that private-insurance premiums for families rose three times faster than median household income over six years and deductibles rose almost five times faster. In 15 states, health-insurance premiums are the equivalent of at least 20% of median household income for people under 65.
While the market has rallied on the back of the Government pumping another $800 billion into the economy to prop up the ailing consumer, the average American remains liquidity-impaired and the U.S. housing market is headed lower, not higher. With these factors still in place, the now positive bias toward stronger-than-expected GDP growth in 2011 can certainly be questioned.
Inflation is a policy that, as Keynes said, confiscates part of the citizens’ wealth. The government’s most recent move, to implement payroll tax cuts while extending unemployment benefits, may go some way to stimulate the economy in the short term but runs a considerable risk of exacerbating the deficit. In this interconnected global economy, as the world’s fastest-growing economies take strong measures to curb inflation, the net effect could be icy for world growth. In the U.S. certainly, from a global and domestic perspective, the evidence is clear that inflation is here to stay on a global basis and Jobless Stagflation is going to impact the economy in 2011.
Function in disaster; finish in style.