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The purpose of this webpage is to provide a dynamic source of time-sensitive research that supports our macro Market Outlook.

For some time, I have theorized that our economy would gradually enter a state of stagflation. While the majority of Wealth Managers held onto hopes for a “Goldilock’s economy”, I created an investment strategy based on stagflation which provided above average gains in 2007 and appreciable gains in 2008. In my Market Outlook, I explain in detail the rationality for my theory and why most wealth management firms have their clients woefully ill-prepared to profit from such a set of circumstances.

I originally posted an article on April 17th, 2007 regarding the probability of a Goldilocks scenario versus Stagflation.

I’ll attempt to update the following table the day after the government’s release of the CPI & PPI figures each month.

1. Data through March
2. Data through April
3. Data through May
Sources:
CPI, Core CPI & PPI: Data obtained from the Bureau of Labor Statistics.
Energy & Food Prices & CRB Index: Data obtained from the Commodity Research Bureau.
All Economic Data obtained from Bloomberg.com

I feel a little silly continuing to track this data as it seems fairly obvious where we are headed. If there were any doubt, the Fed has successfully removed it over the past 9 months with their aggressive easing while paying nothing more than lip service to the threat of inflation. Unfortunately, loose money always leads to inflation but it doesn’t always lead to economic recovery. In fact, the Fed is looking increasingly impotent which I addressed in Part IIIb of my April Portfolio Update, which you can read by clicking here . (Once you click on the link, you’ll need to scroll down the page.) Unfortunatly, the majority of wealth managers are betting on the old axiom “Don’t fight the Fed”, but it might turn out to be a loser’s bet. The Fed has all but promised to keep the liquidity pump primed but the consumer, housing and credit markets aren’t reciprocating in guaranteeing an economic recovery.

A word about CPI
Even though government reported inflation figures are heating up, I continue to maintain that they understate the reality of the situation – a sentiment that is becoming increasingly more popular. The following is a table of various inflation gauges so that you can make your own decision on this matter.

As you can see, there is a remarkable disparity between real commodity price inflation and government reported inflation in Consumer Prices. Personally, I have a very difficult time believing that an explosive 150% increase in the price of commodities has only led to a meager 13.1% increase in Core inflation as the government reports. Since we know that the CRB Index doesn’t lie, then we can be certain that actual inflation in consumer prices has been understated. In my 2007 Annual Report to my clients, I included the following tidbits regarding the unprecedented commodity inflation in our economy:

• Currently, we are experiencing the highest rate of commodity inflation over any five year period – including the 1970’s. In 1973, the five year rate of inflation hit 99%. As of 12/31/07, it is at 103%.
• The last five years have been the only five consecutive years of positive commodity inflation since the CRB index was created in 1957 (Four was the previous record from ’71 – ’74).
• In three of the last six years, commodity prices have increased over 20%.
• In five of the last six years, commodity prices have increased over 10%.

In the 70’s, commodity inflation was like being kicked in the gut. Conversely, today’s commodity inflation is like a series of body blows from a heavyweight fighter. Once the global markets comes to realize just how substantial inflation really is, equity and bond markets will start to feel the pain that the consumers worldwide have been feeling for some time.

If you would like more information on how to protect your portfolio during a period of stagflation, please feel free to contact us.

The MAC is an Independent Firm that provides Wealth Management services to individuals, primarily those in or near retirement, on a fee-only basis. Our goal is to provide our clients positive absolute returns regardless of market movements. We believe that the majority of Wealth Managers focus on wealth creation regardless of risk while we prefer to focus on wealth preservation with an emphasis on risk-adjusted returns.

This is an update to a post I made on May 7th. I’ve copied most of the significant text so I took down the old post.

According to AAA, the average nationwide gasoline price hit another all-time high a couple of weeks ago at $3.22/gallon, besting its previous record of $3.06/gallon on August 11, 2006. Some are calling for energy prices to continue to move up calling for $4/gallon gas. Well, allow me to add some fuel to the speculation fire (pun intended).

Over the last eight months, we have seen an uncharacteristic draw in energy inventories which makes a solid case for higher energy prices this summer. Before I continue, let me provide a quick primer on the nature of energy inventories and shoulder seasons. Read the rest of this entry »

By proceeding, I acknowledge that I have read and understood the Disclaimer, Performance Reporting Disclosure and Copyright Statements .

The following is an update of a post that I wrote on April 17th, 2007 regarding the probability of a Goldilocks scenario versus Stagflation. I’ll update the data on the last day of each month and repost it. The purpose of this post and subsequent updates is to objectively examine the changes in both economic and inflationary data since the Federal Reserve made the decision to quit raising rates in the Summer of 2006. (Click here to view original post.)

In the month of April, Inflation figures moderated a bit. Specifically, the CRB Index and the PPI came down some but that was after a scorching hot February so they were due for some moderating. Energy prices are still climbing and the price of gas at the pump reached an all-time high a couple of weeks ago at $3.22/gallon (Nationwide average according to AAA.) The market is focused on Year over Year (YOY) figures on PCE, CPI and PPI but these are all skewed down because of the big dip in energy and metals prices last fall. PPI and CPI for the trailing 6 months (since November) are at 4.8% and 2% respectively which would be 9.6% and 4% annualized.

The big news is on the economic front. A mixed bag of improving manufacturing and construction data but a big dip in consumer spending. The other significant development was the much larger than expected dip in existing home sales below 6M annualized units. The average home price for existing sales did move up. This can be attributed to the fact that subprime borrows who would buy cheaper homes are being squeezed out of the market by stricter lending standards. While the consumer curtailed his spending, he still has a pretty optimistic outlook of the future as both Confidence and Sentiment improved.

By proceeding, I acknowledge that I have read and understood the Disclaimer, Performance Reporting Disclosure and Copyright Statements .

The following is an update of a post that I wrote on April 17th, 2007 regarding the probability of a Goldilocks scenario versus Stagflation. I’ll update the data on the last day of each month and repost it. The purpose of this post and subsequent updates is to objectively examine the changes in both economic and inflationary data since the Federal Reserve made the decision to quit raising rates in the Summer of 2006. (Click here to view original post.)

In the month of March, Inflation figures continued to heat up (CPI and PPI) while economic numbers improved slightly. Unfortunately, consumer sentiment continues to slip which is one of the better leading indicators. Action in April did nothing to dampen the threat of stagflation which will continue to make the Fed’s job increasingly difficult.

By proceeding, I acknowledge that I have read and understood the Disclaimer, Performance Reporting Disclosure and Copyright Statements .

This morning the government reported an increase in the Consumer Price Index or CPI of 0.6% over last month’s reading while Core CPI rose 0.1%. While the Core number seems “contained”, the real CPI is pretty hot. For the year, CPI is up 1.2% which translates to a 4.8% annualized rate (without compounding that is).

The Fed decided to stop raising rates last August with the assumption that their job in curbing inflation was done. Their job as they foresee it was to cool the economy just enough to bring down inflation but not so much to force it into recession. That’s where the term Goldilocks comes from (not too hot but not too cold – pretty clever, eh.) They stated that their future decisions would be “data dependent”. So let’s examine the data since they made their decision to put off any further rate hikes.

I created the following spreadsheet containing various means of measuring inflation and economic growth. I took the average month-over-month figures from last August and September and compared them to the most recent data available which is January and February. (I used two months in hope of smoothing out any spikes. March figures are not included, but I’ll update this and repost it once they all are available.)

INFLATION DATA		Aug – Sep Ave.		Jan – Feb Ave.		Hot or Cold
Core PCE		0.20%			0.30%			Hot
CPI			-0.10%			0.30%			Hot
PPI			-0.35%			0.35%			Hot
Core CPI		0.20%			0.25%			Hot
Energy Prices(1)	-9.65%			3.49%			Warming
CRB Index		-2.74%			2.00%			Red Hot
Wage Inflation		0.40%			0.80%			Red Hot
Unemployment		4.65%			4.55%			Red Hot
	
ECONOMIC DATA		Aug – Sep Ave.		Jan – Feb Ave.		Hot or Cold
ISM Index		53.5			50.8			Cooling
Construction Spending	0.00%			-0.25%			Cold
Consumer Spending	0.10%			0.60%			Hot
New Home Sales		1.048M			0.893M			Cold
Existing Home Sales	6.24M			6.60M			Warm
Median Sales Price	$222.5K			$211.7K			Cold
Durable Goods Orders	3.85%			-2.65%			Cold
Consumer Confidence	102.4			109.2			Hot
Consumer Sentiment	86.7			90.4			Neutral
	
(1)	Energy prices measured by the CRB Energy Sub-Index
All other data gathered from CBS Marketwatch and Bloomberg News.

So far, its looking like the Fed is failing on both counts. Inflation is hotter than it was last summer and several parts of the economy, mainly housing and manufacturing, are cooling dramatically (the exception being good ol’ consumer spending). Over the last several months, The Fed and Wall Street have been predicting a “Goldilocks” scenario, but the data strongly suggests that it is becoming increasingly unlikely. (I’ll grant that this is just 8-9 months worth of data so it doesn’t necessarily establish a formidable trend, but the picture is certainly much bleaker than what is being promoted by the financial media.)

The opposite of Goldilocks is Stagflation – an old friend from the 70’s. While the term Stagflation is just now being uttered in very dark corners of the financial media, the broad market has dismissed any possibility of it occurring. The yield on every type of income investment including Real Estate is making the bold prediction that inflation will subside. The continued ascension of equity prices is clearly making the case for economic strength. I like the quote by John Hussman of Hussman funds who said “The market has its head in the freezer and its feet in the oven and Wall Street is claiming the temperature is just right.”

Unfortunately, I’m not clever or naïve enough to look at the data and reach an optimistic conclusion. To me, the data is shouting STAGFLATION! - yet very few are listening.

Stagflation: Historical Precedence and Secular Trends
The Stagflation theme plays into my macro view of the markets. I believe that we are currently experiencing a secular bear market that could last another 5-10 years. I define a secular bear market as a 10-20 year period where the stock market doesn’t do squat. (Forgive my Texas vernacular but sometimes my upbringing gets the best of me and I just can’t find an eloquent way of putting stuff.)

In the last 80 years, the US stock market has suffered two secular bear markets [The Great Depression (1929 – 1945) and the Inflationary 70’s (1968 – 1980)]. Each of the two previous secular bear markets can be divided into 4 stages which consist of an 1) Initial Correction then a 2) “Dead Cat Bounce” followed by a 3) Secondary Correction and finally 4) Sideways Action for an extended period of time.

Here’s a timeline of the four stages
Stage				Great Depression	Inflationary 70’s	Tech Bubble
Initial Correction		’29 – ‘32		’68 – ’70		2000 - 2002
Dead Cat Bounce			’33 – ’37		’70 – ’72		2003 - ????
Secondary Correction		’37 – ’38		’73 – ’74
Sideways Market			’38 – ’45		’74 – ‘80

What is interesting is that both Secondary Corrections (’37 & ’73) were characterized by high inflation. The majority of bear markets are deflationary in nature but not in these two cases. In ’37, inflation was created by excessive government stimulus in an effort to recover from the Great Depression. In ’73, inflation was created by the combination of a tremendous increase in input prices primarily associated with the spike in oil and government intervention to devalue our currency (removing us from the Gold standard).

Today we have a combination of all three factors.
1) We have governments hell bent on creating excessive stimulus (while the US government is doing its part, Japan is the most egregious offender in creating inflation).
2) The US government is doing everything in it’s power to devalue our currency. (At 82.08, the US$ is less than a couple of points off its all time low of 80.39.
3) Many input costs including oil and its derivative products have increased more than three-fold in the last several years (the exception being some Soft and Agricultural commodity prices but they are on the move).

If History rhymes, then it stands to reason that this Secondary Correction will be inflationary as well. There are several things pointing to this outcome but I’ll just point out the biggies:
- The appointment of a deflation fighter as Federal Reserve Chairman
- The ever-increasing CRB Index
- The continued free-fall of the US$
- Increasing protectionism
- Record-setting Government deficit spending

While the spreadsheet above only covers 9 months worth of the data, these long-term trends strongly suggest that inflation will continue to haunt the US economy. With that being said, making money in the markets over the next several years will require a radically different strategy than Wall Streets traditional approach of allocating accounts into equities and bonds.