July 15, 2008
THE ROCK AND NOW THE ROLL
Blood is definitely running in the streets these days. The troubles at Fannie Mae and Freddie Mac and the run on IndyMac Bank are only the latest examples of the various ills afflicting the markets and the economy. Discouraging as all this is, the ongoing challenge of upward inflation momentum won't help.
Today's update on wholesale inflation for June suggests that inflation may get worse before it gets better. The annual pace of producer prices was an astonishing 9.1% through last month--the highest since 1981. And there's no salvation in focusing on core wholesale prices, which rose by 3.1% for the year as of June--the highest since 1991.
No matter how you slice it, wholesale inflation has taken wing. We can only guess what tomorrow's report on consumer inflation will show, but it would come as no surprise to see higher numbers on that front as well.
The Fed is still more concerned with disinflation/deflation arising from the liquidity crisis in the finance and real estate sectors, thus the 2.0% Fed funds rate. Perhaps that's prudent, perhaps not. Either way, it doesn't change the fact that the cyclical slowdown has yet to tame the pricing pressures, as the Fed has continually said it would.
Adding to the inflationary woes is the bubbling of prices in overseas markets, starting with China. That's doubly troubling because in China's reaction to fighting rising inflation is less than encouraging. As the Wall Street Journal today reports, "China Falters on Inflation Fight."
Some of the problems are related to the dollar, which continues to weaken. Indeed, the buck hit a new record low against the euro today. China long ago hitched its currency to the greenback, which means that U.S. monetary policy is exported to China. Breaking free of the relationship, which effectively gives China a looser monetary policy than its domestic economy warrants, is proving difficult, in part because to do so threatens to materially slow the Chinese economy. Having grown used to 10% economic growth, China's in no mood to tighten their belts, especially right before the high-profile summer Olympic games. But as the U.S. learned in the 1970s, printing money as a tool for boosting economic growth is, at best, a short-term fix, and one with a hefty price tag once the party's over.
Meantime, oil and many other commodities are priced globally in dollars. No wonder, then, that as the dollar falls, commodity prices rise. Or is it vice versa?
In any case, all eyes will be on Fed Chairman Ben Bernanke in his testimony to Congress today and tomorrow. It's not clear that he can say anything to wipe away the worries, although there's the possibility that he could make things worse if he's not careful with his chatter.
As such, strategic-minded investors should stand ready to start nibbling at asset classes, particularly if they spike down in the coming days and weeks. U.S. stocks, junk bonds and REITs have been particularly hard hit of late. Meanwhile, we're not inclined to chase commodities at these levels, although fully selling out previously established positions isn't recommended either. Nonetheless, if you've owned commodities for some time, it's a good time to start thinking about rebalancing from winners to losers on an asset class level. No, we're not sure that bottoms in stocks, junk and REITs are imminent, but if you have a long-term horizon you could do a lot worse by starting to buy, albeit cautiously and with an eye on time diversifying purchases over the coming months and perhaps even years.
More generally, a fully diversified global portfolio across all the major asset classes is still the only game in town. The good news is that some portions of the global asset allocation pie look more attractive on a long-term basis than others. That's always true, but it's been quite a while since the differences have been so stark. In short, this is no time to be blinded by the volatility. Opportunities like this don't come along every day. Even so, no one said this is going to be easy. Tapping risk premia takes a lot more discipline than it used to. Inflation, it seems, really is everywhere in 2008.
Posted by jp at July 15, 2008 10:20 AM
Quite true. There's a joker in every deck.
Posted by: JP at July 15, 2008 7:07 PM
Inflation, it seems, really is everywhere in 2008, except housing!
Posted by: Kimo at July 15, 2008 1:41 PM