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"The prospects for significant inflation have increased, not only here, but around the world."

-Warren Buffett

One of our core Macro Themes for Q2 of 2010 is “Inflation’s V-Bottom.” Unlike most of Ben Bernanke and Timmy Geithner’s analytical liabilities, inflation in this interconnected world of prices is marked-to-marked, real-time.

Now Timmy has recently admitted that he is “not an economist” and that he really hasn’t ever had a job in the real world, so I won’t waste any time on his incompetence. He’s explained it himself. Bernanke, on the other hand, is a professor and a historian who twilights as an economist, but his forecasts since 2006 have proven to be at least as bad as some of the worst sell-side strategists on Wall Street. That’s pretty bad.

If you didn’t know, other than in your wages and the conflicted and compromises calculation of US Core CPI, inflation is everywhere. In addition to removing every day things like energy and food from its “core” calculus, the US Government has changed the calculation of inflation 9 times since 1996. That’s a lot.

Now the topic of inflation will make the hair on the backs of US stock market bulls stand on end (for the Fed’s Janet Yellen, that can’t be a pretty sight). Make no mistake - the Fed, doves, and bulls have to be in bed together for the SP500 to breach my Q2 intermediate term target of 1214 to the upside. Being willfully blind to inflation trends is a critical aspect of their storytelling.

There are 3 arguments that have a tendency to populate my inbox on the dovish side of this inflation debate:

  1. Unemployment is high
  2. Wages are low
  3. The Fed sees no inflation

I agree with all 3 of these points. Unemployment the lagging indicator that every monkey in the Wannabe An Economist League is staring at. Wages are not inflating anywhere near the annualized pace of prices that real people have to pay for things (the spread between what you make and what you pay is widening). And Bernanke, sees only what a great historian could  – his own confirmation bias about a depression that never happened.

The only great depression I see is the output of points 1-3 on Main Street. For the last decade, the US Federal Reserve has been trained to create a boom and bust economy for Wall Street because that’s how we all get paid. The grand total of US net job adds between 2000-2009 = ZERO.

The perma-bulls cheer Bernanke on because he is daring us to speculate on inflation at the same time that he says he sees none of it. He funds inflation by marking the American citizenry’s return on fixed incomes (savings) to zero percent, and letting Piggy Bankers fly by allowing Wall Street to borrow short and lend long on a marked-to-model fed funds rate.

This thesis isn’t just a machination of my own mind. It’s actually a solution. If you want to create stable consumer spending and small business hiring patterns in this country, give upstanding and unlevered Americans an opportunity to earn fixed incomes on their hard earned cash flows (savings). Warren Buffett gets this and so does the best central banker in the world – Mr. Glenn Stevens at the Reserve Bank of Australia.

Overnight, Stevens took the short term stock market pain for the sake of his citizenry’s long term fixed income and currency gains by raising the Aussi equivalent of a Fed Funds rate by another 25 basis points. This take Australia’s base lending rate 4.5% above the compromised and conflicted fear-mongering bureaucracies of Japan and the United States. This was the 6th time Stevens has raised rates since October – as he’s raised rates, Australian unemployment has gone down!

Without cutting and pasting his entire commentary, here’s what non-group-thinking Glenn had to say about the global economy:

“In both underlying and CPI terms, inflation over the most recent 12 months was around 3 percent. Nonetheless, the extent of decline from here may not be quite as much as earlier forecast and inflation now appears likely to be in the upper half of the target zone over the coming year.

With the risk of serious economic contraction in Australia having passed some time ago, the Board has been adjusting the cash rate towards levels that would be consistent with interest rates to borrowers being close to the average experience over the past decade or more. The Board expects that, as a result of today’s decision, rates for most borrowers will be around average levels. This represents a significant adjustment from the very expansionary settings reached a year ago.

The Board will continue to assess prospects for demand and inflation, and set monetary policy as needed to achieve an average inflation rate of 2-3 percent over time."

Now call me aggressive or call me Mucker - I’m cool with both; but what Warren Buffett, Glenn Stevens, and I are saying here is that inflation doesn’t happen in the vacuum of US domestic politics. Inflation is global. Inflation is created by debtor nations. Inflation, when marked-to-market, isn’t kind.

If you are in the camp that $86/oil or your $2 million dollar 3500 square foot house in Connecticut isn’t inflationary because of where you finally noticed the deflation from the mother of all global peaks in prices in 2008, well… that’s not the real world – sorry to break it to you. For the record, I have one of those inflated houses in CT and I do consider the gas in my cars “core.”

As of last night’s close, Chinese and Indian stocks hit new YTD and 8 week lows, respectively, because governments in those countries agree with governments from Australia to Brazil – inflation continues to accelerate sequentially. It’s just math.

My immediate term support and resistance levels for the SP500 are now 1192 and 1217, respectively.

Best of luck out there today,

KM

Inflation's V-Bottom - STEVENS