Inflation Protection: What's Working, What's Not 10 comments
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As Dr. Leeb articulated so well today, emerging markets are displacing the U.S. as the engine of global commodity prices. The U.S., meanwhile, has a long way to go to clean up its debt-laden economy.
In the short run, this is deflationary, since deleveraging by banks and by consumers is offsetting cheap money from the Fed. This is leading to slow GDP growth, falling home prices, and stubbornly high unemployment.
But massive fiscal and monetary stimuli mean that inflation relief won't last, and will also lead to a weaker U.S, dollar. Investors can protect their portfolios from these outcomes with the nine ETFs noted at the bottom of this article. I am watching them for signals about inflation and the economy, and I have an eye on both trading and long-term portfolio protection.
As for me, I am overweight cash, underweight stocks, and long gold and TIPS.
TIPS Are Sole Winner This Week
The only bets that have been working over the last week are TIPS and WIPS. (These are inflation-protected bonds in the U.S. and abroad.) Since August 12, TIP is up 0.6% while WIP is flat. These investments have consistently acted defensively against inflation, while other inflation-hedging vehicles have not.
Dollar Defies Gravity
DBN is a bearish bet on the U.S. dollar, and it is off only slightly this week. The dollar continues to hold up well despite massive fiscal deficits and cheap money from the Fed. These are stoking concerns about the long-term decline of the greenback, but it is too soon to ride this train.
Why? The Fed has defended Treasurys with remarkable vigor, and I believe that they will pull out all stops to defend the dollar. It won't succeed in the long-run, but it is dangerous to fight the Fed these days (as I note below, in my discussion of bonds).
Commodities Are Riding the Market
The major stock market indices are off 2%-3% during the last four trading days, and commodities are down even more. Oil (as represented by USO) and basic materials (IYM) are both off 4.9%, about twice the decline of stocks. Although I believe that oil and commodities are a good long-term hedge against inflation, in the short run they trade with stocks.
Likewise for precious metals, which are down a more modest 1% to 3%.
Why are commodities mirroring stocks? We are in a liquidity boom that is creating the mother of all asset bubbles, and which tends to push correlations together for all risk assets. The global reflation rally is concentrated in commodities, since these are the clearest beneficiaries of rising global GDP.
That's one of the reasons that I've noted that gold isn't tracking inflation as well as oil and TIPs. In fact, gold is not trading on inflation/reflation lately; instead, investors are looking to gold as a hedge against financial catastrophe.
Bonds: Too Soon to Go Short
As David Fry noted today, it's hard to fade bonds, even though this seems like a logical trade. This is because the Fed is supporting Treasury auctions through quantitative easing. This is inflating the bid/cover ratio, so Fed purchases are making these auctions a "success" in the eyes of many market observers. Kudos go to Zero Hedge for highlighting this issue repeatedly.
Therefore, even though I'd like to short bonds by purchasing TBT, there's no sense fighting the Fed. The TBT is down 6.4% since last Wednesday, making it the worst performer in my inflation basket. It's too early for this trade, and being early is the same as being wrong. (Though being early seems to be intellectually satisfying for certain value investors.)
Defensive Stocks Make Sense, Too
I am underweight stocks because I believe that investors are overlooking bearish signals from second quarter earnings. The reflation rally has been lifting all boats, especially assets with high risk, stocks with high betas, and companies with high operating leverage. The market is ahead of itself, so it's time to be defensive.
In fact, defensive stocks with pricing power make sense during a reflationary/inflationary period. Warren Buffet has mentioned this as an inflation hedge, especially if dividend yields are attractive.
Last week I highlighted five stocks in two defensive sectors, healthcare and tobacco. All four stocks are favorably rated by Zacks for strong trends in earnings revisions. The stocks are Amgen (AMGN), Intuitive Surgical (ISRG), McKesson (MCK), Reynolds America (RAI), and Altria (MO). Altria was downgraded on the day I published the article, so that brings us to four stocks.
Not surprisingly, the two high beta stocks did the worst over the last week, with AMGN and ISRG down 4% each. The tobacco stocks were down less than 1%, and MCK was up 0.4%. McKesson and its peers in medical information are holding up well: Perhaps as investors are finally putting a premium on defensive growth during the latest market pullback.
Symbol | Name | Price 8/17 | Gain/Loss since 8/12 |
Gold | 91.61 | - 1.44% | |
Precious Metals | 32.08 | - 2.02% | |
Treasury Inflation Protected Securities | 100.90 | + 0.58% | |
Int'l Inflation Protected Bonds | 54.00 | -- | |
2x Short 20-yr+ U.S. Bonds | 48.85 | -6.42% | |
Oil : WTI Cash | 35.52 | -4.90% | |
Commodity Basket: Egy, Metals, Ag | 22.36 | -2.99% | |
Basic Materials | 48.63 | -4.85% | |
Dollar Bearish Index | 27.06 | - 0.59% | |
S&P 500 | 98.31 | -2.47% | |
Nasdaq | 38.48 | -3.49% | |
Dow Jones Industial Index | 91.611 | -2.30% |
Disclosure: Long SPY, GLD, TIP
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Larry,
No tobacco for me, either! : )
I joked in my last article that investors could buy Altria and Intuitive Surgical so "they could profit from cigarettes and from the minimally invasive surgical cure." I draw the line with a product that kills the user when it is used as intended.
As for inflation protection, this is meant as part of a diversified portfolio of stocks and bonds. Stocks offer growth, while inflation protection provides principal protection. I believe investors should buy when inflation protection is cheap, and today long-term expectations are still low.
Ideally, a stock would offer a moderate yield and have pricing power, perhaps through the ownership of global commodities. I need to expand my buy list to include energy companies, especially oil exploration and oil service stocks. These are levered to a reflation rally, and I believe that we cannot have normal global growth without oil prices of $100 or more.
By the way, I'm thinking of adding to stocks on a pullback. I have to review some of the bullish arguments, many of which get short shrift on Seeking Alpha. There seem to be a lot of bears and pessimists on the site. And while I appreciate the skepticism on SA, the remarks sometimes lapse into abject cynicism.
Always good to hear from you.
Be well,
Rob
P.S. You are correct about the deflationary impact of low wage growth in our current employment environment. It's going to take a while before we tip over into inflation, so I'm watching the key indicators to see what's moving and why.
><snip>
> P.S. You are correct about the deflationary impact of low wage growth
> in our current employment environment. It's going to take a while
> before we tip over into inflation, so I'm watching the key indicators
> to see what's moving and why.
I understand that inflation is considered a monetary phenomenon, and that wage inflation is a large component of the observed effects. But I'm unsure how to view the potential of this given my view of the increased polarazition of income. With a rapidly shrinking middle class, commensurate with the income distribution patterns now skewed to the two extremes - high and low, I'm having a hard time seeing where the demand-fueled inflationary pressures would originate.
This assumes that lower-income folks would continue to save and reduce spending to, predominately, essentials and the higher income folks would be in a very defensive mode.
If this is true, wouldn't the inflationary pressure be delayed (as you indicate) much longer than recent history would indicate? If money has no velocity, ... I can see how demand outside the U.S. combined with a weaker dollar could increase prices for many essentials, but it seems to me that reduced pricing power for all the other components of the measured inflation that are more affected by the 24% of world GDP formerly provided by the U.S. consumer should more than offset that.
Any thoughts?
I appreciate you time and contributions.
HardToLove
HardtoLove:
Thanks for your question.
Until you raised the issue, I hadn't considered the impact of income inequality on wage inflation. The mathematical definition of income inequality is the Gini Index, which measures the share of income among all people in a population. en.wikipedia.org/wiki/...
The Gini index in the U.S. has been rising for forty years, and has been above 46 since the year 2000. This is the highest level of inequality since measurement began. A high Gini index indicates income inequality, so the middle class HAS shrunk, and incomes have polarized, as you noted.
If the elites in a society can profit by highering low-wage workers, and if unions are absent or powerless, then YOU ARE CORRECT, there will be very little inflation from wages. The middle class and the working poor will suffer eroding purchasing power as inflation rises. This is exactly what has happened to the working class in the U.S. since the 1970s, and it is especially prominent among people without a college education.
The growing disparity of incomes in the U.S. is especially deflationary once we consider the effects of outsourcing. As corporations continue to cut costs and outsource work, we have a "race to the bottom" for wages. This sums up the present-day experience of many corporate workers: Low job security, constant pressure to boost productivity, and the ongoing threat of oursourcing (which hangs over their heads like the Sword of Damocles).
As you noted, the next step is depressed consumer demand, since disposable income has stagnated. Henry Ford avoided this by giving his workers a raise. This was enlightened self interest, since higher wages created a middle class, and a market for his cars.
Finally, we have the impact on commodities from emerging markets. This will NOT be affected by the outsourcing phenomenom or the stagnation of wages in the U.S. As one example, look at gasoline. The average American worker commutes to work for 30 minutes alone in a car. This worker is competing for a gallon of gasoline with six workers in India who will take a cab together, and travel just ten minutes. Long, lonely commutes are a U.S. phenomenom that is being challenged by third-world workers who take buses and public transport to urban centers.
This example is an exaggeration, but it shows how the average U.S. lifestyle will be impacted by outsourcing. Granted, a "leveling of the playing field" will give us cheaper products at Wal-Mart. But it also produces job insecurity, and a sustained rise in prices for global, fungible commodities (such as oil, plastics, chemicals, metals, etc.).
BOTTOM LINE: Wage deflation will continue unless outsourcing is capped, or American workers suddenly become more productive.
Thank you for a thoughtful question. I will adjust my thinking accordingly.
Rob
On Aug 19 08:31 AM H. T. Love wrote:
> On Aug 18 04:35 PM Robert Martorana wrote:
>
> HardtoLove:
>
> Thanks for your question.
><snip>
> inequality is the Gini Index, which measures the share of income
> among all people in a population. en.wikipedia.org/wiki/...
Thanks for that link - another resource garnered! :-)
><snip>
> BOTTOM LINE: Wage deflation will continue unless outsourcing is
> capped, or American workers suddenly become more productive.
>
> Thank you for a thoughtful question. I will adjust my thinking accordingly.
The question was another case of "enlightened self-interest". Since I'm new, and not shy about embarrassing myself by displaying my ignorance, I figure the best way to learn is to just ask. Not all will answer, so the thanks is owed to *you*.
I have a history, in my past life, of thinking outside the box. Since I had heard so much about all the inflation we (c/sh)ould expect, my natural inclination was to try and determine how I could tell when to switch horses mid-stream. It doesn't seem easy to determine.
As I thought about what I had learned were the causes of inflation, my "associative processor" clicked and I realized the Fed could say inflation was not imminent because they knew the spending patterns could not return to normal for a very long time due to the lack of velocity of money and lack of credit creation (as fewer people desire credit while they de-leverage and save, and fewer can qualify for credit - ding! That triggered the thought of income disparity).
Anyway, that's how the question originated. I was hoping to learn some more "stuff".
I *do* appreciate your taking the time and say thanks.
HardToLove
I thought this might be of interest to you, if you've not already seen it.
The last four paragraphs on page three of this article,
www.nytimes.com/2009/0...
seems to me to have large implications.
" What any policy changes will mean for the nonwealthy remains unclear. There have certainly been periods when the rich, the middle class and the poor all have done well (like the late 1990s), as well as periods when all have done poorly (like the last year). For much of the 1950s, ’60s and ’70s, both the middle class and the wealthy received raises that outpaced inflation.
Yet there is also a reason to think that the incomes of the wealthy could potentially have a bigger impact on others than in the past: as a share of the economy, they are vastly larger than they once were.
In 2007, the top one ten-thousandth of households took home 6 percent of the nation’s income, up from 0.9 percent in 1977. It was the highest such level since at least 1913, the first year for which the I.R.S. has data.
The top 1 percent of earners took home 23.5 percent of income, up from 9 percent three decades earlier."
Note that the top earners incomes rose an ominous 6.666 times during that period, 30 years. It would be interesting to see what the increases were for similar periods for various income strata, maybe in 20 percent bands.
Distributing only 76.5% of income among 99% of the population would seem to have predictable negative consequences that go beyond just near-term standards of living. The reduction in wealth-building capability of that 99%, via better education, starting up small businesses, ability to provide for retirement and medical emergencies, etc., seems certain to deliver long-term deleterious effects on the nation as a whole.
While I'm not a socialist in any common sense of the word, "enlightened self-interest" would dictate that a society can not allow such disparity to predominate for long if it wishes to continue to prosper.
I do *not* ever suggest the government as a solution to anything - it's role is purely as a service provider. I think that the shareholders (owners) of the wealth producing entities of this country need to look beyond their noses and make adjustments to compensation that maintain the expertise needed for their institutions to prosper while distributing more of the generated wealth to a greater percentage of the "grunts" that actually execute on the plans that top management institutes.
That has long-term beneficial effects directly to the institution (internal organic growth of management talent, loyalty of employees which reduces turn-over costs, etc.). As a side-effect (maybe entirely unintended), it benefits the social fabric of the nation.
HardToLove
HardToLove,
Thanks for the NY Times link.
Income inquality is doing two things to this country:
1) Feed populist passions
2) Increase reliance on the rich for our taxes
First, we are seeing populism lead to the vilification of the rich, and not just Bernie Madoff. There is widespread resentment of Wall Street, and we have seen people respond with either Libertarian leanings or with plans for income redistribution. I could probably articulate this better if I were a sociologist--or if I were Peggy Noonan. : )
Second, this country relies very heavily on taxes on the super rich. The data below show that the top 1% of U.S. taxpayers pay 40% of ALL income taxes, and the top 5% pay more taxes than the remaining 95%. By relying on the super-rich, U.S. income taxes have become as volatile as the stock market itself.
www.ntu.org/main/page....
______________________...
I agree 100% with your comment:
"I think that the shareholders (owners) of the wealth producing entities of this country need to look beyond their noses and make adjustments to compensation that maintain the expertise needed for their institutions to prosper while distributing more of the generated wealth to a greater percentage of the "grunts" that actually execute on the plans that top management institutes."
Time and again I have seen top managements at companies reward themselves handsomely at the expense of the grunts. I love capitalism, but I know exploitation when I see it. When CEOs do 1% of the work and get 10% of corporate earnings, THAT is exploitation.
On the bright side, the Internet offers some relief. I know people who are using the Web to launch businesses at near-zero costs: They work from home and use Internet sites to distribute their content, market their business, and serve clients. THIS IS A GAME CHANGER, and not just for businesses like music. Software programmers, financial advisors, attorneys, and a host of other white-collar workers can send their expertise through a fiber-optic cable to clients anywhere on earth for free. With a marginal cost of zero, it allows people to set up shop who could never do it before. Here is an example from the music business:
In the old days, you needed a record company, and they got the lion's share of profits. Famous musicians could sell millions of records, but they got only a fraction of the revenues. With the Internet, bands can now survive on micropayments, and make a decent living off of 10,000 records.
Granted, distribution channels still count for a lot. It is much easier to flourish on iTunes, which keeps a big chunk of artists' revenue. But the Internet is gradually making it easier for people to profit directly from their own work as it continually reduces the costs of marketing and distribution. Today you can email content, conduct conference calls, and even host online meetings--with a marginal cost of zero. This dilutes the advantages of big firms, which have traditionally relied on economies of scale to reduce operating costs.
It will take time for the business models to adapt, but the profits are there. The profits will be smaller, but a greater percentage will go to the workers.
Thanks again for your comments. It's always a pleasure.
Rob
On Aug 24 02:44 PM Robert Martorana wrote:
> <snip>
For white-collar and any intellectual service, product sales, etc. the internet is a big enabler.
What we need is a way to enable blue-collar, skilled artisans and others that provide labor to partake of the wealth generated. Some of the profit from those who benefit from the 'net will flow to local service providers, but it really leaves them at the weak end of the chain.
In this country we have de-valued "craftsmanship" to the point that what used to be well-paying middle class jobs have been relegated to status of "peon". I may be old-school, but I still admire those who have developed and honed their skills to a fine art. I want to see them thrive.
We, as a society, need a mechanism whereby these folks are also able to advance their wealth-building ability while pursuing their chosen craft with pride.
I know this is a great deal of dreaming of an ideal world, but without dreams how do we strive to improve what is to become some part of what may be?
I used to cajole my co-workers with "perfection is acceptable". When the expected responses came I would explain that it was not expected, but the pursuit of it allowed us to excel and do a better job than otherwise. The trick is to not let the failure to achieve perfection become an obsession.
Oh well, I've taken too much of your time. Thanks for the post and the excellent points you made.
HardToLove
> On the bright side, the Internet offers some relief. I know people
> who are using the Web to launch businesses at near-zero costs: They
> work from home and use Internet sites to distribute their content,
> market their business, and serve clients. THIS IS A GAME CHANGER,
> and not just for businesses like music. Software programmers, financial
> advisors, attorneys, and a host of other white-collar workers can
> send their expertise through a fiber-optic cable to clients anywhere
> on earth for free. With a marginal cost of zero, it allows people
> to set up shop who could never do it before. Here is an example from
> the music business:
>
> In the old days, you needed a record company, and they got the lion's
> share of profits. Famous musicians could sell millions of records,
> but they got only a fraction of the revenues. With the Internet,
> bands can now survive on micropayments, and make a decent living
> off of 10,000 records.
>
> Granted, distribution channels still count for a lot. It is much
> easier to flourish on iTunes, which keeps a big chunk of artists'
> revenue. But the Internet is gradually making it easier for people
> to profit directly from their own work as it continually reduces
> the costs of marketing and distribution. Today you can email content,
> conduct conference calls, and even host online meetings--with a marginal
> cost of zero. This dilutes the advantages of big firms, which have
> traditionally relied on economies of scale to reduce operating costs.
>
>
> It will take time for the business models to adapt, but the profits
> are there. The profits will be smaller, but a greater percentage
> will go to the workers.
>
> Thanks again for your comments. It's always a pleasure.
>
> Rob
HardToLove:
You raised another good point: The devaluation of skilled trades in America. Plumbers, electricians, masons, and carpenters are valuable to the country, yet these occupations do not get the recognition they deserve.
I expect the pendulum to swing back to skilled trades, however, as college costs continue to escalate. The cost/benefit of a college education is waning, especially when corporations can outsource their workers in a pinch. Thus, an 18-year-old might now opt for a skilled trade instead of college. In four years, he or she will have a small business and no college loans, vs. a college degree, lots of debt, and prospects for minimal job security.
Thanks again for the exchange. I am considering working them into a new post: "Outsourcing and the Deflation of the American Dream".
Rob
I look forward to it!
HardToLove
On Aug 25 12:57 PM Robert Martorana wrote:
>
> HardToLove:
>
> You raised another good point: The devaluation of skilled trades
> in America. Plumbers, electricians, masons, and carpenters are valuable
> to the country, yet these occupations do not get the recognition
> they deserve.
>
> I expect the pendulum to swing back to skilled trades, however, as
> college costs continue to escalate. The cost/benefit of a college
> education is waning, especially when corporations can outsource their
> workers in a pinch. Thus, an 18-year-old might now opt for a skilled
> trade instead of college. In four years, he or she will have a small
> business and no college loans, vs. a college degree, lots of debt,
> and prospects for minimal job security.
>
> Thanks again for the exchange. I am considering working them into
> a new post: "Outsourcing and the Deflation of the American Dream".
>
> Rob