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Is More Inflation Headed Our Way? PDF Print E-mail
Written by Eddy Elfenbein - Crossing Wall Street   
Friday, 18 April 2014 11:09

“Inflation is taxation without legislation.” – Milton Friedman

The stock market has recovered a good deal from last week’s momentum-induced slide. The S&P 500 rallied all four days this week, and the exchanges are closed today for Good Friday. All told, this was the best week for the S&P 500 since July.

This is an exciting time for the market. We’re moving into the heart of earnings season. Already about one-fifth of the S&P 500 has reported earnings; 52% of the reports have beaten on revenues, and 63% have beaten on earnings. Both numbers are about average. (That’s right, on Wall Street, beating expectations is to be expected.)

Despite this resurgence, I think the market’s shift to value, which I discussed in last week’s issue, still has some room to play out. I expect to see growth names, especially the pricey ones, lag the overall market. Investors should continue to be conservative and not tempted to chase after bad names.

In this week’s CWS Market Review, I want to address an important topic—the threat of inflation. In the eyes of the stock market, inflation is Public Enemy #1. I want to emphasize that I don’t believe the threat is serious, for now, but there’s already some evidence that inflation’s years-long decline could be over. I’ll have more to say about that in a bit.

I’ll also talk about recent earnings reports from Wells Fargo (pretty good) and IBM (rather blah). Plus, I’ll preview a slew of Buy List earnings coming our way next week, including Ford, Microsoft and Qualcomm. But first, let’s look at where we stand with regard to inflation.

Is More Inflation Headed Our Way?

Those of you old enough to remember the 70s certainly remember inflation. It was the worst thing about that decade. Well…that and disco. Every week, it seemed, prices climbed higher, and the prime rate went up, up, up.

There’s no way to sugarcoat it. Inflation is devastating for investors. It eats away at savings, and it knocks stock prices for a loop. On December 31, 1964, right before inflation became a problem, the Dow closed at 874.13. Exactly seventeen years later, the index stood at 875.00. Stock prices had barely budged, yet the Consumer Price Index had tripled. Then, once inflation got under control, stock prices soared. So much of the 1980s bull market was really making up for lost ground.

Inflation also has an unusual impact on earnings. Not all earnings are the same, and inflation exacts a heavy toll on asset-heavy businesses. Companies with high assets relative to their profits tend to report ersatz earnings.

Let’s look at some recent figures. Last Friday, the Labor Department reported that the Producer Price Index rose by 0.5% last month. That was the biggest increase in nine months. Economists like to track prices at the wholesale level because it’s often an early warning sign of price increases at the consumer level. Digging into the details, the rise in the PPI was driven by a 0.7% increase in wholesale services and a 1.1% rise in food prices. The core rate, which excludes food and energy, rose by 0.6%.

Then on Monday, the Consumer Price Index report showed that consumer prices rose 0.2% last month. That’s still not much, but it was more than the 0.1% economists were expecting. The core consumer rate also rose by 0.2% for its biggest monthly increase in 14 months.


Of course, some of the bad news about inflation could really be good news about the economy. Consumers are buying more stuff, and workers are harder to come by. We had another good initial claims report this week. The price of shrimp, of all things, is at a 14-year high. There have been a lot of silly predictions of about the imminent return of hyper-inflation. Don’t be fooled: every single one of these predictions has failed. The truth is that inflation has been remarkably low—and not just low, but low and stable. The year-over-year core inflation rate has stayed between 1.5% and 2.3% for the last 35 months.

I’m not going to try to predict if inflation will come back, but we have to be realistic and watch the data. One important indicator is the spread between the 5-year Treasury yield and the 5-year TIPs. This is the market’s view of what the CPI will be over the next five years. The “breakeven” spread increased this week to 2.24%, which is up 0.13% since Monday. Also, the back end of the yield curve is starting to flatten. The spread between the 5- and 30-year Treasuries just narrowed to its smallest point in five years.

A few years ago, I ran the numbers on how the stock market reacts to inflation. Here’s what I found:

Now let’s look at some numbers. I took all of the monthly returns from 1925 to 2012 and broke them into three groups. There were 75 months of severe deflation (greater than -5% annualized deflation), 335 months of severe inflation (greater than 5% annualized), and 634 months of stable prices (between -5% and +5%).

The 75 months of deflation produced a combined real return of -46.77%, or -9.60% annualized. The 335 months of high inflation produced a total return of -70.84%, or -4.32% annualized. The 634 months of stable prices produced a stunning return of more than 177,000%. Annualized, that works out to 15.21%, which is more than double the long-term average.

Here’s an interesting stat: The entire stock market’s real return has come during months when annualized inflation has been between 0% and 5.1%. The rest of the time, the stock market has been a net loser.

The Fed’s target for inflation is currently 2%, and we’ve been below that for some time. Fed Chair Janet Yellen said that’s probably due to lower energy prices and lower import prices. I want to make it clear that I don’t think inflation is a problem or will soon be a problem, but the era of rock-bottom inflation may be over. To some extent, a small increase of inflation could be beneficial. American firms are currently sitting on more than $1.6 trillion in cash, and a small boost to inflation might cause them to spend more.

The bottom line is to ignore the doom and gloom crowd. There’s no danger of hyper-inflation but it’s very likely that inflation will creep up to the Fed’s target zone. That will be another reason for the Fed to raise rates. As long as the yield curve is steep, the math is in the stock market’s favor. But the steep curve won’t last forever. Now let’s look at some recent earnings.

Good Earnings from Wells Fargo, Blah Earnings from IBM

Last Wednesday, Wells Fargo (WFC) reported Q1 earnings of $1.05 per share, which beat estimates of 97 cents per share. This was the 17th quarter in a row in which Wells has reported earnings growth.

Wells continues to be the strongest large bank in the country. As expected, their mortgage business got hit hard last quarter, but we saw that coming. Still, Wells was able to grow its loan portfolio by more than $4 billion. Their total loan portfolio now stands at $826.4 billion.

The results were particularly welcome for two reasons. One is that the earnings from competitor and former Buy List member JPMorgan Chase were pretty ugly. The other reason is that shares of WFC were sliding going into the report. Clearly, some traders were nervous, and the results quelled that. Wells Fargo remains a very good buy up to $54 per share.

IBM’s (IBM) earnings were a different story. First, I have to remind investors that many cheap stocks are cheap for a reason. The question to ask is how serious are those reasons. IBM is in a rough patch right now. In many ways, I think the company is in a place similar to where Microsoft was a few years ago.

For Q1, IBM reported earnings of $2.54 per share, which matched Wall Street’s estimate. Big Blue had revenues of $22.48 billion, which missed estimates by $320 million. This is the eighth sales decline in a row. The details weren’t pretty. Hardware sales dropped 23%. System-storage sales also dropped 23%. Software sales rose by just 1.6%. The market was not pleased, and IBM got knocked for a 3.4% loss on Thursday.

Perhaps the most impressive part of the earnings report was that IBM reiterated its forecast of earning $18 per share for this year. Wall Street doesn’t buy it, but it’s noteworthy that IBM hasn’t backed away from that forecast. I like IBM here, but it’s a longer-term story. The stock is going for less than 11 times this year’s earnings. IBM is a good buy up to $197 per share.

Seven Buy List Earnings Reports Next Week

Get ready for a lot of earnings news next week. On Tuesday, CR Bard and McDonald’s are scheduled to report Q1 earnings. CR Bard (BCR) was one of the surprising winners in the early part of this year until the shares pulled back this month. On the last earnings call, Bard said to expect Q1 earnings to range between $1.83 and $1.87 per share. For the whole year, they see earnings between $8.20 and $8.30 per share. I like this stock. Bard has increased its dividend every year since 1972. Expect another increase in a few months. CR Bard is a good buy up to $152 per share.

McDonald’s (MCD) has beaten earnings for the last two quarters, which ended a period in which they missed earnings four times in five quarters. The fast-food joint is working to turn itself around, and some of the early results look promising. Wall Street currently expects Q1 earnings of $1.24 per share. I also like MCD’s dividend, which is currently over 3.2%. MCD remains a buy up to $102 per share. I’m keeping a tight range, so don’t chase it. Let’s wait until we see strong results.

On Wednesday, April 23, Stryker and Qualcomm are due to report earnings. Three months ago,Stryker (SYK) not only beat expectations but also guided higher for the year. Interestingly, the stock initially dropped after the good news. After that, the stock rallied until the middle of February and has bounced along ever since then. The Street sees Q1 earnings of $1.08 per share, which is probably a penny or two too low. I’m curious to hear what they have to say for guidance. For now, I’m keeping my Buy Below at $90, which may have to come down soon. But Stryker is a fine buy.

Qualcomm (QCOM) may be one of my favorite stocks on the Buy List right now. Next to DirecTV, it’s our second-best performer this year. The stock is inches away from another multi-year high. Last month, Qualcomm gave us a nice 20% dividend increase, and three months ago, they sang our favorite tune—the beat-and-raise chorus. A lot of tech heads will be watching this report for clues about Smartphone sales. QCOM is a buy up to $87 per share.

On Thursday, Microsoft (MSFT) will report its fiscal Q3 earnings. It’s odd to see MSFT and its new CEO get so much good press lately. It wasn’t that long ago that MSFT was written off as a dinosaur that was desperately behind the times. Thanks to the hate, we jumped in and made a cool 40% last year with Microsoft. The Street expects 63 cents per share, and I think we’re going to see a nice beat. MSFT is a very good buy up to $43 per share.

On Friday, April 25, Moog and Ford Motor are due to report. Moog (MOG-A) was a big disappointment last earnings season. They missed by a penny and lowered guidance. The stock got crushed—although by the early part of April, it had made back a lot of what it had lost. That’s one plus to owning high-quality stocks. They often bend but rarely break. In this earnings report, I want to hear if business has improved. Moog remains a good buy up to $66 per share.

Ford (F) is also one of my favorite stocks, and I think the shares are very much undervalued. This is a crucial time for Ford, as they’re rolling out several new models this year. Business is improving in Europe, and they may break even this year. The consensus on Wall Street is for earnings of 31 cents per share. I’ll tell you right now, Ford will beat that. Ford is a solid buy up to $18 per share.

That’s all for now. Stay turned for lots more earnings next week. You can see our complete Buy Listearnings calendar here. Be sure to keep checking the blog for daily updates. I’ll have more market analysis for you in the next issue of CWS Market Review!

- Eddy


The Economy & Bond Market: Strengths Weaknesses & Opportunities PDF Print E-mail
Written by Frank Holmes CEO & Chief Investment Officer U.S. Global Investors   
Monday, 14 April 2014 00:39

Treasury bonds fell sharply this week as the market received clarity on the Fed’s intentions, with the equity market sell-off also providing support. The two-year Treasury yield spiked higher in mid-March, after Fed Chairman Janet Yellen inferred in her inaugural press conference, that interest rates could head higher within six months after the end of quantitative easing (QE), which implied roughly the first quarter of 2015. This timeline was a bit more aggressive than the market had expected and sold off only to completely reverse within the past three weeks. This came as various Fed speakers and Federal Open Market Committee (FOMC) minutes have clarified the Fed’s position, which could mean it is in no rush to raise interest rates.





  • Preliminary same-store sales data for March was better than expected, rising 2.8 percent even with an onslaught of poor weather for a good portion of the month.
  • Initial jobless claims fell to a seven-year low, suggesting that the job market is improving. Job openings also hit a six-year high, showing there are positions to be filled.
  • The NFIB Small Business Optimism Index rose in March as business owners expect the economy to improve.  



  • PPI rose faster than expected in March, jumping 0.5 percent versus the expectation of 0.1 percent.
  • Consumer debt rose by $16.5 billion in February, with student loans being a driver. There has been a lot of negative press recently on the total size of student loans and the potential for another government “bailout” or loan forgiveness.
  • Economic data out of China was disappointing this week and the market continues to look to the government for some form of fiscal stimulus. 


  • The Fed has reiterated its intention to not raise interest rates before economic data supports that decision.
  • The International Monetary Fund (IMF) recently released a report highlighting the deflation risk in Europe. This is the type of thinking that could spur additional easing policies from the European Central Bank (ECB).
  • There are many moving parts to the taper decision and while the Fed began the process, it is very possible that tapering could be delayed if the economy stumbles.


  • In addition to the inherent difficulties in exiting the QE program and the potential for a misstep, there is also the potential for miscommunication from the Fed with the recent change in leadership.  
  • Trade and/or currency “wars” cannot be ruled out which may cause unintended consequences and volatility in the financial markets.
  • China remains a wildcard for economic recovery and the economy has shown some cracks in recent months. This is similar to how last year started and China found its footing. Something similar needs to happen this time around.
By Frank Holmes
CEO and Chief Investment Officer
U.S. Global Investors






Listening to the Canary PDF Print E-mail
Written by Terry Coxon - Senior Economist   
Friday, 11 April 2014 01:01

During World War II, the British Royal Air Force (RAF) undertook a plan of misdirection to allow a squadron of bombers to approach an exceptionally valuable target in Europe undetected. The target was so heavily guarded that destroying it would require more than the usual degree of surprise.

Although the RAF was equipped to jam the electronic detection of aircraft along the route to the target (a primitive forebear of radar was then in use), they feared that the jamming itself would alert the defending forces. Their solution was to “train” the defending German personnel to believe something that wasn't true. The RAF had a great advantage in undertaking the training: The intended trainees were operating equipment that was novel and far from reliable; and those operators were trying to interpret signals without the help of direct observation, such as actually seeing what they were charged with detecting.

At sunrise on the first day, the RAF broadcast a jamming signal for just a fraction of minute. On the second day, it broadcast a jamming signal for a bit longer than a minute, also around sunrise. On each successive day, it sent the signal for a somewhat longer and longer time, but always starting just before sunrise.

The training continued for nearly three months, and the German radar personnel interpreted the signals their equipment gave them in just the way the British intended. They concluded that their equipment operates poorly in the atmospheric conditions present at sunrise and that the problem grows as the season progresses. That mistaken inference allowed an RAF squadron to fly unnoticed far enough into Europe to destroy the target.

People will get used to almost anything if it goes on for long enough. And the getting-used-to-it process doesn't take long at all if it's something that people don't understand well and that they can't experience directly. They hear about Quantitative Easing and money printing and government deficits, but they never see those things happening in plain view, unlike a car wreck or burnt toast, and they never feel it happening to themselves.

QE has become just a story, and it's been going on for so long that it has no scare value left. That's why so few investors notice that the present situation of the US economy and world investment markets is beyond unusual. The situation is weird, and dangerously so. But we've all gotten used to it.

Here are the four main points of weirdness:

  1. The Federal Reserve is still fleeing the ghost of the dot-com bubble. It was so worried that the collapse of the dot-com bubble (beginning in March 2000) would damage the economy that it stepped hard on the monetary accelerator. The growth rate of the M1 money supply jumped from near 0% to near 10%. This had the hoped-for result of making the recession that began the following year brief and mild.
  1. A nice result, if that had been all. But there was more. Injecting a big dose of money to inoculate the economy against recession set off a bubble in the housing market. Starting in 2003, the Fed began gradually lowering the growth rate of the money supply to cool the rise in housing prices. That, too, produced the intended result; in 2006, housing prices began drifting lower.

    But again, there was a further consequence—the financial collapse that began in 2008. This time, the Federal Reserve stomped on the monetary accelerator with both feet, and the growth of the money supply hit a year-over-year rate of 21%. It's still growing rapidly, at an annual rate of 9%.

Screen Shot 2014-04-11 at 2.04.00 PM

  1. The nonstop expansion of the money supply since 2008 has kept money market interest close to zero. Rates on longer-term debt aren't zero but are extraordinarily low. The ten-year Treasury bond currently yields just 2.7%; that's up from a low of 1.7%.

    The flow of new money has been irrigating all financial markets. In the US, stocks and bonds tremble at each hint the Fed is going to turn the faucet down just a little. And it's not just US markets that are affected. When credit in the US is ultra-cheap, billions are borrowed here and invested elsewhere, all around the world, which pushes up investment prices almost everywhere.

  1. US federal debt management is living on borrowed time. The deficit for 2013 was only $600 billion, down from trillion-dollar-plus levels of recent years. But this less-terrible-than-before figure was achieved only by the grace of extraordinarily low interest rates, which limit the cost of servicing existing government debt. Should interest rates rise, less-than-terrible will seem like happy times.

Almost no one imagines that the current situation can continue indefinitely. But is there a way for it to end nicely? For most investors, the expectation (or perhaps just the hope) that things can gracefully return to normal rests on confidence that the people in charge, especially the Federal Reserve governors, are really, really smart and know what they're doing. The best minds are on the job.

If the best minds were in charge of designing a bridge, I would expect the bridge to hold up well even in a storm. If the best minds were in charge of designing an airplane, I would expect it to fly reliably. But if the best minds were in charge of something no one really knows how to do, I would be ready for a failure, albeit a failure with superb academic credentials.

Despite all the mathematics that has been spray-painted on it, economics isn't a modern science. It's a primitive science still weighted with cherished beliefs and unproven dogma. It's in about the same stage of development today that medicine was in the 17th century, when the best minds of science were arguing whether the blood circulates through the body or just sits in the veins. Today economists argue whether newly created cash will circulate through the economy or just sit in the hands of the recipients.

Let's look at the puzzle the best minds now face.

If the Federal Reserve were simply to continue on with the money printing that began in 2008, the economy would continue its slow recovery, with unemployment drifting lower and lower. Then the accumulated increase in the money supply would start pushing up the rate of price inflation, and it would push hard. Only a sharp and prolonged slowdown in monetary growth would rein in price inflation. But that would be reflected in much higher interest rates, which would push the federal deficit back above the trillion-dollar mark and also push the economy back into recession.

So the Fed is trying something else. They’ve begun the so-called taper, which is a slowing of the growth of the money supply. Their hope is that if they go about it with sufficient precision and delicacy, they can head off catastrophic price inflation without undoing the recovery. What is their chance of success?

My unhappy answer is "very low." The reason is that they aren't dealing with a linear system. It's not like trying to squeeze just the right amount of lemon juice into your iced tea. With that task, even if you don't get a perfect result, being a drop or two off the ideal won't produce a bad result. Tinkering with the money supply, on the other hand, is more like disarming a bomb—and going about it according to the current theory as to whether it's the blue wire or the red wire that needs to be cut means a small failure isn’t possible.

Adjusting the growth of the money supply sets off multiple reactions, some of which can come back to bite. Suppose, for example, that the taper proceeds with such a light touch that the US economy doesn't tank. But that won't be the end of the story. Stock and bond markets in most countries have been living on the Fed's money printing. The touch that's light enough for the US markets might pull the props out from under foreign markets—which would have consequences for foreign economies that would feed back into the US through investment losses by US investors, loan defaults against US lenders, and damage to US export markets. With that feedback, even the light touch could turn out not to have been light enough.

To see what the consequences of economic mismanagement can be, and how stealthily disaster can creep up on you, watch the 30-minute documentary, Meltdown America. Witness the harrowing tales of three ordinary people who lived through a crisis, and how their experiences warn of the turmoil that could soon reach the US. Click here to watch it now.



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17 April 2014 ~ Michael Campbell's Commentary Service

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