Order of the Day: Managing Inflation Risks

A weaker consumer base, lower capacity utilization, and contraction in manufacturing may continue to counter inflation for now. The helicopter sorties by which the Fed drops cash out of the sky on the economy could be on hold for a while due to Tuesday’s housing numbers and BRIC concerns over dollar devaluation risks.

Notes & Comments for June-16-2009

• Economic Data #1: For the month of May 2009, Producer Price Inflation came in much better than expected at 0.2% vs. consensus estimates at 0.7% and previous month at 0.3%. Energy prices are responsible for the much of the increase with a +2.9% increase while the food component fell -1.6%. Overall, the annualized rate for the PPI is -4.7% vs. April’s -3.5%. The weak economy is keeping inflation at bay for now. Rising energy prices are always a threat and consumers are still smarting from energy’s mercilessly beating during the 2008 run-up in prices. Inflation also remains a long-term threat as a result of unprecedented amounts of federal government spending and devaluation of the dollar.

• Economic Data #2: For the month of May 2009, Industrial Production dropped -1.1% vs. consensus estimates of -1.0% and previous month at -0.7%. It should come as no surprise that auto manufacturing and parts (down -7.9% vs. April’s -1.2%) were the main contributing source of weakness for the report. Excluding autos and parts, industrial production fell -0.9% vs. April’s -0.7%. Capacity Utilization also contracted to 68.3% vs. consensus estimates at 68.4% and previous month at 69.1%. Again, the data points to a deceleration in the pace of economic contraction, but still underlies its weakness. The low capacity utilization should also counter inflation for now, but once manufacturing activity increases along and the Fed reacts with tightening, it will probably be a different story.

• Consumer Watch: Gallup Polls continue to show a declining trend in Consumer Spending. Based upon a 14 day average period, Americans are not willing to spend or charge any more than $60 on a daily basis. The Redbook report for chain store sales was quite anemic at -4.8% annualized decline. Granted, Wal-Mart’s (WMT) withdrawal from participation in this survey removes a significant amount of sampling, but when a retailer like Best Buy (BBY) (which recently gained market share and competitive advantages upon Circuit City’s bankruptcy) reports disappointing earnings and gives negative guidance, it should raise more than an eyebrow. I would not anticipate things getting any better any time soon with high unemployment rates and HELOC ATMs no longer in service. Monday, B of A and Amex both reported increases in consumer credit card default rates. Connect the dots for yourself. Related Securities: XLY; RTH; BBY

• Bond Watch: Tuesday the Fed bought $6.45bn of the $31.3bn in 3 year treasury notes. Thus far, the Fed has purchased $163bn out of the $300bn in treasuries that it intends to buy. While fulfillment of this plan is a daunting prospect, it is temporary relief that the Fed is no longer discussing the possibility of expanding this plan. However, since Chairman Bernanke has not officially retreated from this strategy and continues to keep this option available, it remains an unresolved market risk. Related Securities: IEF; TLT; TBT

• Real Estate: For the month of May 2009, Housing Starts rose by an unexpected +17.2% vs. April’s -12.9% decline. Most of the positive turnaround is attributed to the multi-family component (5 units or more) of the report, which rose 61,7% vs. April’s -49.4% decline. The single family component rose +7.5% vs. April’s 3.3% increase. Regionally, the strongest activity emerged in the west at +28.6%, followed by the south’s +16.8% and midwest’s 11.01%. The northeast was the weakest area of the country with only a +2.0% gain. Overall, building permits were up +4.0% vs. April’s -2.5%, but on an annualized basis are still down -47.0%. Some are calling the report another "green shoot" because of the favorable month-to-month comparison, but it should be discounted due to seasonal patterns and give less credit to pent-up demand. Related Securities: XHB; IYR;HD; LOW

• Currency Watch: Barely 24 hours have elapsed since Russia’s finance minister voiced his support for the U.S. dollar. However, with the BRICs (i.e. Brazil, Russia, India, and China) convening in Russia, the issue of creating an alternative reserve currency is back on the table. As the world turns and changes, we may inevitably witness the emergence of a legitimate rival reserve currency but it will not happen overnight. There is no reason to believe that America can defy history and become the only country to maintain its global hegemonic currency status on a permanent basis. Typically, wars and inflation are the root of a nation’s economic demise or long-term stagnation, especially when it insists on doing the same things over and over in anticipation of different results. Am I selling America short? Absolutely not! But, I do believe we have hit a wall in terms of economic innovation. Lest we forget, it took centuries for Rome to collapse even after its sacking and burning. While there is still time, there is always hope. Related Securities: UUP; UDN

• Baltic Dry Index: For June-16-2009, the dry bulk shipping index is up +188 at 3951. Some China experts claim that China has just about completed its stockpiling of commodity supplies and foresee a drop in this source of demand. Others also point to the extra supply of new dry bulk carriers coming to market as a cause for a future drop in daily shipping rates. Related Securities: SEA

Managing inflation risks and global accountability to U.S. creditors is the order of the day. Easier said than done, but self-realization will put one on the path to self-improvement.

(These notes and comments are not intended to be a comprehensive analysis, but instead merely highlight current themes and events for the convenience of readers and encourage them to make and share their own conclusions.)

Disclosure: Hillbent.com, Inc. or its affiliates may own positions in the equities mentioned in our reports. We do not receive any compensation from any of the companies covered in our reports.