Oil Closes at $100.74, Gold at New Highs, Stagflation



The Federal Open Markets Committee (FOMC) meeting minutes shared today voiced both recessionary and inflationary concerns.

The committee’s first concern was over consumer spending, which, after growing between 2.8% and 3.6% a year for the past five years will slow to 1.7% for FY 2008 and FY 2009 [1]. Since discretionary spending comprises approximately 70% of GDP, this slowdown shows signs of a weakening economy, one that may very nearly be racing towards recession. The contraction in spending is no where more apparent than in the earning numbers posted by both high end and low end retailers. Blue Nile, after reporting earnings which disappointed Wall Street expectations saw its share price tumble by more than 20%. Best Buy, arguably the most efficient seller of consumer electronics also disappointed the street and citing tough macroeconomic conditions cut its FY 2008 earnings estimates by 2-4% [2]. Consumer spending is slowing. Coupled with projected declines in housing prices between now and 2010, rising unemployment, and low consumer confidence levels, the trend is unlikely to turn, and in this author’s viewpoint more likely to decline further.

Perhaps even more concerning is that this contraction is not limited solely to the consumer. A survey conducted by ChangeWave, a Rockville, MD based firm, suggests that IT spending is likely to abate as well. Twenty-three percent of the surveyed firms indicated they planned to cut their IT spending for at least Q2 2008. Forty-three percent indicated that it was business as usual - good news until to learn that this represents a 9% decline since the previous survey. Some businesses, it seems, are cutting expenditures as well. Despite these seemingly gloomy forecasts, leading economists adamantly hold to the notion that the United States will avert a recession. The FOMC forecasts growth for between 1.2 - 2.0% this year. And although these numbers seem inflated relative to International Monetary Funds (IMFs) forecast of 0.8%, are still positive.

It is this scenario, that of a sluggish growth period for Q1 and Q2 this year that market bulls rest their hopes. Today’s market rally with the Dow Jones Industrial Average up ~90pts, was based on Fed meeting minutes that seem to support and bolster these hopes. Both headline and core inflation were surprisingly strong. At 0.3%, core inflation reached its highest levels since 2006 [3]. With ostensibly unstoppable momentum, the price of of commodities, precious metals, and agriculture have continued to rise, and in many cases, have made new all time highs. The doubling of wheat prices, caused in part by increased demand from globalization and decreased supply due to ethanol production, have caused rampant increases in the prices of everything grain related (pasta, pizza, bread). Producers of these products are being forced to pass the increase in their input costs to consumers. And so, from the perspective of investment managers, current inflation contradicts theories of a slowing global economy led by a United States recession. On the surface that may appear to be good news. But consumers spending a greater portion of their income on basic necessities leaves less room for the other discretionary items that drive the economy. This author’s personal view, supported without any factual information to back it up, is that institutional investors and not supply imbalances are currently driving the boom in commodities. Unable to procure investment grade debt instruments, and fearful of a further slowdown in consumer discretionary spending, investors are unable or simply unwilling to commit capital to Financial, Consumer, and with that last month, Information Technology stocks. With interest rates declining and expected to be cut to 2.0% percent, investors are wary of holding cash denominated in U.S. Dollars. Take out all that “bad stuff” and you are left with energy, commodities, and agriculture.

Demand for these products are strong, but when the fundamentals catch up, watch out. Oil inventories for example, have been building week over week for the last five weeks while the price of oil has steady marched past $100.00, even surpassing $101.00 today. I highly doubt building inventories to be a bullish economic indicator. Nevermind the fact that India announced this week that its economy was showing signs of slowdown as well. I wonder, how much of the inflation we are seeing can be attributed to speculation?

[1] Americans Are Putting the Brakes on Spending
[2] Slowdown For Best Buy
[3] Data fuel fears of US stagflation

February 20, 2008 | Filed Under Commodities, Energy, Etc 

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