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A day after the Chairman of the Federal Reserve gave the all-clear on inflation, the Bureau of Labor Statistics produced its monthly Producer Price Index (PPI) showing a rise in prices on the business level. A closer inspection of the data, ex-food and energy, would seem to resolve any inflation concern, except for an old troubling issue once regularly discussed here at the column, but since lost in the wake of recessionary deflation.

Producer prices were reported increased by 0.3% in October, marking the sixth monthly price rise of the last 12 months. Price increase in a period of recession might seem counterintuitive, but as we know well by now, Headline PPI is influenced by wild swings in energy prices. Taking a longer-term look at the metric shows the Headline Producer Price Index is in fact down 1.9% from where it stood a year ago. Recall, oil prices started their trek downward from mountainous peaks in July of 2008, and by October of that year still had a ways to fall. Despite the mid-term trend, though, dollar weakness and reviving Emerging Market demand (read China) seem sure to keep pricing stable-to-higher moving forward.

Both volatile components of Producer Prices that regularly drive wild monthly swings in Headline PPI, energy and food, increased a substantial 1.6% in October. Gasoline price increase of 1.9% was mostly behind the big increase in finished energy prices. Higher residential power costs and liquefied petroleum gas contributed the rest. On the Intermediate Goods level, higher diesel fuel and natural gas shipped to electric utilities and commercial electric power drove pricing. Behind all this were rising energy prices on the Crude Level. Natural gas prices increased 16.3% in October based on the BLS produced index, and higher coal and petroleum contributed as well.

A 9.0% higher Grains Index, and also increased prices for slaughter poultry, factored significantly in increased foods prices on the Crude Level. On the Finished Foods level, 24.2% higher vegetable prices led the push.

When excluding volatile food and energy prices from the October measurement, Core Producer Prices declined 0.6%. That's a figure we can find more consistent with the recessionary times. However, when compared against the prior year Core Producer Price Index, prices are actually up 0.7% versus year ago levels.

Today's reported PPI rise of 0.3% compared against economist expectations for a greater price increase of 0.5%. That's good news, but an even better result was found in the Core Producer Price Index comparison to expectations. The decline in Core Prices of 0.6% last month compared against economists' expectations for a rise of 0.1%. Core prices fell for the second month in a row (-0.1% in September), but have only declined four out of the last twelve months (though also 4 out of the last 6). So why then have prices held up relatively well in such a tumultuous environment? That's the subject of a follow on feature article coming soon.

Note:

If you are concerned about inflation, you may consider some inflation protection funds or other hedges. Some useful tools may include: Western Asset Inflation Management Fund Inc. (NYSE: IMF), Western Asset/Claymore Inflation- Linked Opportunities & Income Fund (NYSE: WIW), Western Asset/Claymore Inflation-Linked Securities & Income Fund (NYSE: WIA), Market Vectors Gold Miners ETF (PCX: GDX), ETFs Gold Trust (NYSEArca: SGOL), PowerShares DB Gold (NYSE: DGL), SPDR Gold Shares (NYSE: GLD), Ultra Gold ProShares (NYSE: UGL), AMERICAN CENTURY VP INFLATION P (Nasdaq: AIPTX), AMERICAN CENTURY VP INFLATION P (Nasdaq: APTIX), American Century Inflation Prot Bd A (Nasdaq: APOAX), American Century Inflation Prot Bd B (Nasdaq: APOBX), American Century Inflation Prot Bd C (Nasdaq: APOCX), American Century Inflation Prot Bd Instl (Nasdaq: APISX), American Century Inflation Prot Bd Inv (Nasdaq: APOIX), American Century Inflation Prot Bd R (Nasdaq: APORX), BlackRock Inflation Protected Bond A (Nasdaq: BPRAX), BlackRock Inflation Protected Bond B (Nasdaq: BPIBX), BlackRock Inflation Protected Bond Black (Nasdaq: BPLBX), BlackRock Inflation Protected Bond C (Nasdaq: BPRCX), BlackRock Inflation Protected Bond Instl (Nasdaq: BPRIX), BlackRock Inflation Protected Bond Svc (Nasdaq: BPRSX), DB USD IG INF USD IG INFLATION (LSE: XUIT.L), DFA Inflation-Protected Securities I (Nasdaq: DIPSX), DWS Inflation Protected Plus A (Nasdaq: TIPAX), DWS Inflation Protected Plus B (Nasdaq: TIPTX), DWS Inflation Protected Plus C (Nasdaq: TIPCX), Alliance Resource Partners L.P. (Nasdaq: ARLP), Alliance Resource Holdings (Nasdaq: AHGP), Atlas Pipeline Partners L.P. (NYSE: APL), Atlas Pipeline Holdings (NYSE: AHD), Atlas Energy Resources (NYSE: ATN), Boardwalk Pipeline Partners (NYSE: BWP), Breitburn Energy Partners (Nasdaq: BBEP), Buckeye Partners (NYSE: BPL), Buckeye Holdings (NYSE: BGH), Calumet Specialty Products (Nasdaq: CLMT), Capital Product Partners (Nasdaq: CPLP), Cheniere Energy Partners (AMEX: CQP), Constellation Energy Partners (PCX: CEP), Copano Energy (Nasdaq: CPNO), Crosstex Energy (Nasdaq: XTEX), DCP Midstream Partners (NYSE: DPM), Dorchester Minerals (Nasdaq: DMLP), Duncan Energy Partners (NYSE: DEP), Eagle Rock Energy Partners (Nasdaq: EROC), El Paso Pipeline Partners (NYSE: EPB), Enbridge Energy Partners (NYSE: EEP), Encore Energy Partners (NYSE: ENP), Energy Transfer Partners (NYSE: ETP), Energy Transfer Equity (NYSE: ETE), Enterprise Products Partners (NYSE: EPD), Enterprise GP Holdings (NYSE: EPE), EV Energy Partners (Nasdaq: EVEP), Exterran Partners (Nasdaq: EXLP), Ferrellgas Partners (NYSE: FGP), Genesis Energy (AMEX: GEL), Global Partners LP (NYSE: GLP), Hiland Partners (Nasdaq: HLND), Holly Energy Partners (NYSE: HEP), Inergy (Nasdaq: NRGY), Inergy Holdings (Nasdaq: NRGP), Kinder Morgan Energy Partners (NYSE: KMP), K-Sea Transportation (NYSE: KSP), Legacy Reserves (Nasdaq: LGCY), Linn Energy (Nasdaq: LINE), Magellan Midstream Partners (NYSE: MMP), MarkWest Energy (NYSE: MWE), Martin Midstream Partners (Nasdaq: MMLP), Natural Resource Partners (NYSE: NRP), Navios Maritime Partners (NYSE: NMM), NuStar Energy (NYSE: NS), NuStar GP Holdings (NYSE: NSH), ONEOK Partners (NYSE: OKS), OSG America (NYSE: OSP), Penn Virginia Resource (NYSE: PVR), Penn Virginia GP Holdings (NYSE: PVG), Plains All American (NYSE: PAA), Quest Energy (Nasdaq: QELP), Quicksilver Gas Services (NYSE: KGS), Regency Energy Partners (Nasdaq: RGNC), Rio Vista Energy (Nasdaq: RVEP), Spectra Energy Partners (NYSE: SEP), Stonemor Partners (Nasdaq: STON), Sunoco Logistics Partners (NYSE: SXL), Targa Resources (Nasdaq: NGLS), TC Pipelines (Nasdaq: TCLP), Teekay LNG Partners (NYSE: TGP), Transmontaigne Partners (NYSE: TLP), Vanguard Natural Resources (NYSE: VNR), Western Gas Partners (NYSE: WES), Williams Partners (NYSE: WPZ) and Williams Pipeline (NYSE: WMZ).

Disclosure: No Positions

Remember a few weeks back when Burlington Northern (NYSE: BNI) and Union Pacific (NYSE: UNP) sank the transports and the Dow on warnings that the economy was not steaming ahead after all? BNI's stock derailed that day, but Warren Buffet, who owned a major stake in the company, demonstrated why he is the world's greatest investor of all-time. While the world was selling BNI like it was the plague, America's Grandpa was putting together a plan to buy the rest of the company's outstanding shares.

Buffet Buys Burlington Northern OutrightRemember that old adage, "Buy into fear and sell into greed?" As well-known as it is, it remains mostly misunderstood. It seems it goes against human nature to walk toward danger, but the answer to the riddle is found deeper within that philosophy. It is precisely because what seems dangerous is not always really so bad that opportunity exists. Our savings, however, is so important to our security-centric mindset that we cannot bear the risk of losing, and so we lose out.

Buffet's big trick is that he thinks differently. He considers first the long-term you see, and until they invent the Star Trek transporter, there will be a need for traditional transportation methods. Buffet, acknowledging this, thought here's a wonderful opportunity to take a greater stake in a key transportation company that supplies a fantastic economy.

Berkshire Hathaway Inc. (NYSE: BRK-A, BRK-B), Buffet's investment vehicle and conglomerate, agreed to acquire Burlington Northern Sante Fe (NYSE: BNI) today. Berkshire is acquiring the 77.4% of the company it did not already own. The deal, valued at $44 billion when including the $10 billion in debt obligations that Berkshire will take on, prices Burlington Northern at $100 a share. The acquisition price represents a 31.5% premium to the prior day closing price of $76.07. That's a nice short-term windfall for BNI investors. And isn't it just so Buffet like to set the acquisition price at $100 even!?! Buffet called the deal "an all-in wager on the economic future of the United States." You gotta love this guy...

Buy Railroads, Sell Truckers

Buffet likes railroads for the long-term because of what's going on in energy. As demand for oil and its distillates likely fires in the years ahead, truckers like J.B. Hunt (Nasdaq: JBHT), Landstar System (Nasdaq: LSTR) and Con-way (NYSE: CNW) face an economic impact four times more expensive than the railroads, according to Buffet. If this is truly the case, you could expect market share gains to ensue for the railroads, and at the expense of the truckers. Market share gains are often drivers of P/E expansion as well, and they certainly are drivers of earnings growth. Therefore, railroads should produce better than recent earnings growth and share price appreciation. Add to that the whammy of prospective economic recovery, and you have something worth owning. As a result, you might find strategic investors and profiteers alike seeking to buy railroads now. Thus, the shares of all the segment's stocks should rise.

This deal places the P/E of Burlington Northern at 18.2X BNI's estimated 2010 earnings of $5.51. Union Pacific's (NYSE: UNP) relative P/E ratio is 13.1, according to Yahoo Finance and its data providers. CSX (NYSE: CSX), another major rail player, sees a P/E of 13.1 as well. BNI's P/E was 13.8 before this deal was effected, and the slight premium probably had a lot to do with Buffet's growing interest, in every respect of the phrase.

While we do not offer investment advice here, another investment idea might be to play the market share trend by buying the railroads and selling the truckers, though economic recovery benefits all players, including the truckers. However, you negate that factor by evenly matching the two sides of the deal, or you might overweight the rails if you believe in the economic driver.

Now keep in mind that Buffet's reasoning ignores the possibility of changes in technology. While expecting the transporter beam to become reality any time soon might be far-fetched, it is possible truckers might find another way to fuel the big rigs and regain competitiveness. However, that does not seem to be soon coming either. The power train of a big truck seems a big stretch to be run by electric, natural gas, hydrogen fuel cells or any other prospective technology anytime soon. However, if that does become reality, you can sure bet Buffet will be buying truckers, or whichever segment adopts new cost effective technology.

Disclosure: No Positions

New Home Sales were reported down 3.6% in September, and measured well below economists' expectations. This unexpected disappointment sank stocks on October 28th, as one would expect it might. The Dow Jones Industrials Index slumped 1.21%, while the S&P 500 moved 1.95% lower on the day. Housing stocks took an especially hard hit, with Toll Brothers (NYSE: TOL) slipping 5.5%; Hovnanian (NYSE: HOV) down 5.4%; Comstock (Nasdaq: CHCI) off 9.5%; Pulte (NYSE: PHM) -3.8%; D.R. Horton (NYSE: DHI) -4.0%; Lennar (NYSE: LEN) -4.0%; and K.B. Homes (NYSE: KBH) off 2.2%.

Still, for those who noticed a conflict in the data and did not quite understand why it exists, the report offered confounding information. After all, the New Home Sales slump contrasted against last Friday's reported strong Existing Home Sales pace (+9.4%) for the same month. So which is it then? Which data point is telling the truth? Is housing stabilizing or is it about to take another shot to the gut?

The Difference

The clear difference between Existing and New Home Sales is of course foreclosures, or the absence of them within the New Home Market. Their existence in the pre-owned home market has impacted pricing (pushing prices downward), while also speeding the recent sales pace within the segment. When reported on Friday, most interpreted the sharp increase in Existing Home Sales as the beneficiary of the expiring incentive provided by the First-Time Homebuyers Tax Credit. The theory goes that those who could were rushing to enjoy the tax benefit before its end of year expiration, and we are sure this is the case to some degree. However, first time homebuyers are allowed to buy new homes just as soon as existing properties, so why the drop in new home sales then? Well, that question tells us something more.

"I just do not believe a jobless recovery is possible when the jobless rate is as high as it is now."

Maybe the impact provided by government incentives is losing its punch. Perhaps we should face the fact that a new normal is going to rule the day. Credit standards have tightened, and so the growing American home ownership rate, which characterized recent times, might stall for a long while to come. I do not believe a jobless recovery is possible when the jobless rate is as high as it is now. The unemployed and under-employed are certainly not qualifying for mortgages anyway. At the very least, any economic growth in the short-term should not be robust.

Most "gurus" would not venture out on a limb like that just ahead of a GDP report that is expected to show a return to economic growth, and a sharp bump up at that. But, while GDP will likely look good for Q3, "cash for clunkers" will not a recovery make beyond the quarter, in my view. Heck, I do not even expect to see much inventory build benefit yet, and that factor would be expected to provide a quarterly kicker, before a step back into recession (or rather negative change in GDP) for another quarter. Given consumer spending appears to be giving way to consumers hiding in their basements for the winter, economic recovery might lag a bit.

A Closer Look at the Report

While the annual pace of home sales slipped to 402,000 from a revised August rate of 417,000 (from 429K), the trend was not consistent across geographical regions. The Northeast held steady against August sales, and the Midwest experienced a 34% increase in the pace. The South (-10%) and West (-10.6%), where development is predominant and where prices ran most ramped, drove the monthly slowdown. Foreclosures are also most common in those same important regions, and so, they likely put distance in the variation between market segments as well.

Inventory of New Homes for sale stuck at 7.5 months in September, versus the same in August, but was much improved from the 10.9 months stock available last September and the peak inventory of 12.4 months seen in January. Still, inventory did not change this last month, which may be showing us an inflection point toward forward deterioration.

In conclusion, a boost in sales that is supported by foreclosure activity is akin to A-Rod's batting statistics, supported by performance enhancing drugs. Eventually the beneficial effects wear off, replaced by troublesome side effects and a good look at reality - drug addiction. So, as foreclosures thin out, we expect the Existing Home Sales pace will better match its New Home cousin. In the meantime, I would suggest trusting the new home sales figures a bit more. After all, they don't cheat.

Go Phillies!

Disclosure: No Positions

The Merriam-Webster Dictionary defines “railroad” as “to convict with undue haste and by means of false charges or insufficient evidence.” The definition seems to fit snuggly around what happened on Wall Street Friday, while also offering an interesting play on words. Based on popular press reports, investors convicted the market on the earnings data and forecast warnings of a couple key railroad companies. Specifically speaking, Friday’s downturn was placed squarely on the engine car of Burlington Northern Sante Fe (NYSE: BNI).

Railroad companies and other shippers of goods, including truckers like J.B. Hunt Transport Services (Nasdaq: JBHT) and shipping companies like DryShips Inc. (Nasdaq: DRYS), are considered barometers of the economic lifecycle. After all, if manufacturers and distributors are moving product, it is going to be visible in the results of the shippers.

 

So when Burlington Northern reported third quarter results that fell short of analysts’ consensus, a call to arms went up. Investors moved even more to the defensive when the popular press pointed out how well Burlington’s bad news complemented the dastardly economic diagnosis out of its railroad peer Union Pacific (NYSE: UNP) from just one day earlier. The corporate leaders of both important transportation firms noted a common view for little improvement in the year ahead.

 

Burlington Northern’s shares tanked 6.5% Friday, and while aided by Union Pacific’s 5.5% decline, drove the DJ Transportation Average (^DJT) down 3.5% on the day. Lower moves for the Dow Jones Industrials and S&P 500 Index Friday erased a previously established gain for the week. The Dow slipped only fractionally through the period, while the higher-flying S&P 500 Index moved about 1% lower on the week.

 

Still, we are not so sure you can blame the railroads for the market’s re-evaluation. After all, even an overwhelmingly stellar earnings season could not keep Wall Street on track Friday. Microsoft (Nasdaq: MSFT) and Amazon.com (Nasdaq: AMZN) both reported market-pleasing news last week, though Microsoft’s lift came from its forward guidance. Amazon’s estimate beating result simply aligned the tech giant with 81% of the S&P 500 companies that have bested estimates this quarter, according to Thomson Reuters. We should note that just less than 50% of traded firms have reported results thus far for the third quarter.

 

The overwhelmingly positive earnings trend, coupled with a less than surefooted recent market response, suggests to us that stocks may be fully valued currently. The S&P 500 Index is up 60% since the closing low set on March 9 of this year. Thus, stocks would need further economic reasoning to move higher in the months ahead. You would think the market might have found its economic reasoning in Friday’s Existing Home Sales data though. Sales of pre-owned homes ran at an annual pace of 5.57 million in September. That otherwise dismal rate compared favorably against the economists’ consensus for 5.35 million and against August’s 5.10 million sales pace. However, the market found a flaw in those numbers, since first-time homebuyers are about to lose their special incentive to purchase when the relative federal tax credit expires at the end of the year. The rush to buy now is attributed to the processing time involved in buying a home and qualifying for the credit. We note, however, that many industry experts expect another extension of this important incentive for 2010.

 

Given Wall Street’s modest reaction to good news at current valuation, and its tendency to run for cover at the sighting of a single cloud, market correction seems possible through the short-term. Unfortunately, a solid support for the market seems about to be pulled away. Paper gains and tax consequences are perhaps keeping institutions and retail investors alike from selling-off stocks. Most stock sales now would lock in taxable profits for the 2009 tax year. Thus, as the fiscal year for many a fund manager concludes, and a significant minority of them will before December, investors are likely to exchange winning holdings for cash or other securities. While that exchange could include perhaps shares in companies better positioned for this point in the economic cycle, short-term market consolidation would seem likely from November through January. 

Disclosure: No Positions

Wednesday's business news is highlighted by earnings reports from eBay (Nasdaq: EBAY), Boeing (NYSE: BA), Wells Fargo (NYSE: WFC), U.S. Bancorp (NYSE: USB), VMware (NYSE: VMW), Amgen (Nasdaq: AMGN), Eli Lilly (NYSE: LLY), Kinder Morgan (NYSE: KMP, KMR), Northern Trust (Nasdaq: NTRS), P.F. Chang's (Nasdaq: PFCB), Penn National Gaming (Nasdaq: PENN) and Tractor Supply (Nasdaq: TSCO). Oil inventory data also seems sure to stir the market when released at 10:30 ET, and the Fed's Beige Book is due for release in the afternoon. You might also catch the SEC forum on "dark pools" if you can. We cover all these topics here.

Economic Data

Mortgage Activity

The Mortgage Bankers Association (MBA) made its regular reporting of weekly mortgage activity today. After adjusting for Columbus Day, the week ending October 16 proved a difficult one. As the average contracted rate on 30-year fixed rate mortgages inched higher to 5.07% from 5.02% (15-year mortgages to 4.51%, from 4.44%), mortgage activity dropped sharply. The Market Composite Index of mortgage activity volume declined 13.7% on a seasonally adjusted basis. The drop was driven by a steeper 16.8% week-to-week fall in the Refinance Index, and confirmed by the 7.6% fall in Purchase Activity. The decline marks the second straight, and as first time home buyer tax credits expire, without new legislation, housing seems likely to stumble near-term. However, we expect a renewal or extension of the incentive.

Oil Inventory Report

With the nearest WTI Crude futures trading up to approximately $78 now, the weekly oil inventory data gains in its influence of trading. The sensitivity of futures pricing to news of all sorts increases as trader interest intensifies. Trader interest intensifies as price volatility increases, and the viscous cycle is reborn.

Last week's Petroleum Status Report noted an increase in oil stocks of 0.4 million barrels. A sharp draw in fuel stocks combined with a weakening dollar last week to push oil higher. Total motor gasoline inventories fell by 5.2 million barrels in the week ending October 9. Distillate fuel inventories fell by 1.1 million barrels. However, Indian Summer is taking the Northeastern US by surprise this week, which should offset any further draws in heating oil and settle crude oil as well. The Northeast is the most important market in the States for heating oil, and so weather in New England plays a key role in price trend. The dollar is finding support in the words of market gurus, but we expect there's less weight in those words these days than in years past.

Beige Book

The Fed's Beige Book of regional economic indicators is due for afternoon release at 2 PM. This notation of regional conditions might offer insight into future Fed plans. Also on tap, several Fed speakers are due to take podiums around the country. Look for Fed Governor Tarullo to speak in Washington at 1 PM ET. Richmond's Jeffrey Lacker answers questions at 3:45 ET and Boston's Eric Rosengren will kick off the Fed's Cape Cod Economic Conference. The topic of discussion: Re-evaluating regulatory and monetary policy... Timely...

SEC Reviews Dark Pools

The Securities and Exchange Commission will not be surveying swimming pools around the country for chemical balance, as the terminology implies. Rather, they will be reviewing investment vehicles/methods/systems known as "dark pools," and discussing whether they need special checks and balances. This SEC "open meeting" will hear all sides of the argument, including Wall Street's renewed interest in being left alone.

"But how dark are dark pools?"

Dark Pools allow for anonymity of trading, keeping stocks in check as important players take significant interests in sometimes illiquid stocks incognito. But how dark are dark pools? If some traders have information that the rest of the market is not privy to, then we have a problem. Institutions now use dark pools to trade up to 15% of daily equity volume. It makes sense for institutions that do not want to drive the price of the stock they have interest in owning, thereby forcing a higher cost and sometimes negating opportunity. Still, things have to be kosher boys, and we're not sure you can be trusted anymore. Give us a few more months of gains though and we'll see what we can do...

Earnings Reports

Boeing is off slightly to start the day, as the plane maker posted a $1.6 billion loss on development charges related to its 787 and 747 models. The market was already well-aware of the troubles with the new jumbo jet, so the impact was minimized in today's trade. Still, Boeing (NYSE: BA) was forced to slash its full year forecast to $1.35 to $1.55, from a previous target of $4.70 to $5.00. Analysts were already looking for $1.53 on average, thus the modest decline. Still, with all the delays, one has to wonder if the "big plane projects" project might be better off scrapped. Maybe you just can't fly a plane that big safely. I know I would never board one after all this trouble at Boeing and Airbus.

Wells Fargo (NYSE: WFC) shares are up slightly to start the day, as its solid loan business offers traders safe-haven. Wells' results offered higher loan losses like its peers at Bank of America (NYSE: BAC), J.P. Morgan (NYSE: JPM) and Citigroup (NYSE: C), but it made so much money in interest income from its acquired Wachovia mortgage assets that it about covered charges for an increased level of losses. Without a significant volatile trading business to account for, Wells' income stream seems more predictable, and certainty is valuable these days.

Note though, that there are times when risk is in demand, and coming out of economic trough, that's usually the case. So, while Wells' may be the safest hold over the long-term, it may just as soon underperform its player peers in the near-term. We've already seen low quality stocks lead the way out of the hole though, and so stocks like Wells might be drawing some capital from the sidelines now.

Disclosure: No Positions