Sitting on a Signal: Clear(?) Signal Expected on 11/3

The Federal Reserve Open Market Committee (FOMC) last met to discuss the condition of the economy on Sept 21. The U.S. central bankers said they were “prepared to provide additional accommodation if needed to support the economic recovery.” They also left the benchmark lending rate in a range of zero to 0.25 percent while noting that inflation measures were at levels “somewhat below” the central bank’s mandate to achieve stable prices and full employment. The Fed statement boosted speculation that the central bank will buy more Treasuries sometime later this year.

Fed observers are expecting that the FOMC will announce a new program of quantitative easing (QE) after they meet on November 2-3.

In a post on October 8, I asked myself "what are some signals to look for? A rally up to S&P 1170 might inspire some profit taking, with bargain hunters looking to test the water around 1130. Breaking through and closing below 1130 should alert investors to look for signs of a shifting mood." The thresholds were breached in stride and all in apparent anticipation of the expected new QE.

Now, look at the graphs used in that post, updated to the most recent info. There is also a new look with the US dollar index line added in these graphs to illustrate the level of correlation to the currency which has been strong since the end of May in many markets.

One Eye on The Fed: The Other Eye on The Dollar

Here is a 9 minute video clip that is timely and helpful in understanding the currency challenges facing the major global economies. The discussion revolves around more money printing from the Fed and what Taylor believes will be the impact on the US$. Taylor then offers a high conviction trade suggestion at the very end.

John Taylor, chairman and founder of FX Concepts Inc., discusses the outlook for currency markets. Taylor, speaking with Erik Schatzker on Bloomberg Television's "InsideTrack," says another round of quantitative easing is mostly priced into the market and that the U.S. dollar will weaken through the end of November before recovering. (Source: Bloomberg)

Quantitative Easing: Pushing on a String?

John Hussman has published another in his series of weekly articles that is a must read. In the article titled "Bernanke Leaps into a Liquidity Trap" he describes his opinion of what should be expected from more expansion of the 'monetary base' or quantitative easing. One of his points is...

Certain economic equations and regularities make it tempting to assume that there are simple cause-effect relationships that would allow a policy maker to directly manipulate prices and output. While the Fed can control the monetary base, the behavior of prices and output is based on a whole range of factors outside of the Fed's control. Except at the shortest maturities, interest rates are also a function of factors well beyond monetary policy. 

Market Data: Week Ending October 22, 2010

Market Index	2009   Close	10/22  Close	Week Change	Simple YTD %
Dow Industrials Avg	10428.05	11,132.78	0.63%	6.76%
S&P 500	1115.1	1,183.08	0.59%	5.75%
Fed Funds Rate	0.25%	0.20%	-0.02%	0%
10 yr T-note Yld	3.85%	2.55%	-0.01%	-1.30%
5 yr T-note Yld		1.15%	-0.04%
5 yr infl adj Note		-0.52%	-0.02%
Implied 5 yr Inflation %		1.67%	-0.02%
2 yr T-note Yld	1.14%	0.35%	-0.01%	-0.79%
2-10 Yr Slope	2.70%	2.20%	0.00%	-0.50%
90 day T-bill Yld		0.12%	-0.01%
Gold ($/oz)	$1,096.95	$1,325.10	-3.54%	20.80%
WTI Oil ($/brl)	$79.36	$81.69	0.54%	2.94%
VIX "Worry Index"	21.68	18.78	-1.31%	-13.38%
Credit Spreads		10/22  Close	Week Change
Inv Grade Credit Idx		4.30%	-0.04%
Low Grade Credit Idx		7.95%	0.01%
Markit CDX Inv Grd Idx		97	-1.02%
Markit CDX Mid Grd Idx		157	1.29%

One Eye on China: West Moving East

Here is an insightful, and brief, perspective from Hong Kong of the cultural and economic changes we are beginning to observe in frequent headlines. Andrew Sheng, the Chief Advisor to China Banking Regulatory Commission and former Chairman of Hong Kong Securities and Futures Commission, writes these comments in a 9/15/2010 opinion article in Caixin, the online newspaper, titled Confusing Hong Kong's Reversion with Submersion. There is a lot of critical rhetoric directed at China coming from elected and unelected politicians in the US. Their talk is cheap. Understanding the problem, understanding the culture, and working towards mutual agreement is the task. Jawboning is not going to help. The differences between the east and the west are big. However the need for both the east and west to cooperate is just as big. Doing so with a cooperative mind set will last a lot longer than cooperation out of single minded, self preservation motivations.

Out of the top 40 think tanks in Asia, Singapore had 4 and Hong Kong had only 1 (Hong Kong Center for Economic Research).

Of course, think tanks are not necessarily the best measure of thinking, because the rating system was based on publications in English.  My response to anyone who says that China is not transparent enough is that they often mean China is not transparent in English. It is pretty transparent in Chinese. But India comes out of this rating with 10 out of 40, Japan 7 and China 6.  These English-based think tanks assume that non-English speakers don't think.

Investor Risk Profile Survey

One lesson learned from the global financial crisis is that the markets we invest with, and we trust to be regulated and efficient, are possibly not worthy of our investment and trust. Since there are no other markets for investing, and interest rates available to savers are lower than inflation (hence savers will lose purchasing power/money), what do you do. If your answer is do what I've always done because it will get better, you may be the answer to the rhetorical question "who is the bigger fool".

It is essential someone understands the risk your investment capital is exposed to. In a previous post, risk was discussed in more depth, to explain the concept. One of the points found in that post is for investors to understand the probability of negative or positive outcomes. Think of investing from the perspective of gambling centers such as Las Vegas, Macau or Monte Carlo. When you arrive in town, you become a number in a statistical formula that attempts to predict the odds for where you will spend your cash and how much you of your cash you will leave with. What do you understand about the ways to spend or keep your money in their town? What do you understand about how to increase your cash while playing in their town with their games and their employees?

Market Data: Week Ending October 15, 2010

Market Index	2009  Close	10/15  Close	Week Change	Simple YTD %
Dow Industrials Avg	10428.05	11,062.78	0.51%	6.09%
S&P 500	1115.1	1,176.19	0.95%	5.19%
Fed Funds Rate	0.25%	0.22%	0.01%	0%
10 yr T-note Yld	3.85%	2.56%	0.17%	-1.29%
5 yr T-note Yld		1.19%	0.09%
5 yr infl adj Note		-0.50%	-0.03%
Implied 5 yr Inflation %		1.69%	0.12%
2 yr T-note Yld	1.14%	0.36%	0.02%	-0.78%
2-10 Yr Slope	2.70%	2.20%	0.15%	-0.50%
90 day T-bill Yld		0.13%	0.02%
Gold ($/oz)	$1,096.95	$1,372.00	1.95%	25.07%
WTI Oil ($/brl)	$79.36	$81.25	-1.71%	2.38%
VIX "Worry Index"	21.68	19.03	-8.11%	-12.22%
Credit Spreads		10/15  Close	Week Change
Inv Grade Credit Idx		4.34%	0.17%
Low Grade Credit Idx		7.94%	-0.04%
Markit CDX Inv Grd Idx		98	0.00%
Markit CDX Mid Grd Idx		155	-1.27%

Health Care CPI Rant

Pardon me for ranting but it is too big to ignore. One of the most explosive sources of inflation in the US economy is the cost of health insurance, now that house inflation is contained (Owners Equivalent Rent, 25% of CPI, which was flat August to September). The section of the BEA table that monitors health care costs does not seem to reflect that health insurance premiums are 15%-20% higher than this time last year. My personal experience is that this rate of change has been an annual occurance. The reason is not that the BEA survey does not include hospital charges. But obviously there is an important disconnect between the cost of health insurance and the costs reported by medical service delivery components. Here is some of the BEA's description of how they collect data for all of the measurement area's.

September 2010 Consumer Price Index

From the Bureau of Economic Activity today:
The Consumer Price Index for All Urban Consumers (CPI-U) increased 0.1 percent in September on a
seasonally adjusted basis, the U.S. Bureau of Labor Statistics reported today. Over the last 12 months,
the all items index increased 1.1 percent before seasonal adjustment.

Increases in food indexes and another rise in the gasoline index contributed to the all items seasonally
adjusted increase this month. Four of the six major grocery store food group indexes increased in
September as the food index posted its largest increase since October 2008. The gasoline index rose
again in September, leading to a third consecutive increase in the energy index despite a decline in the
index for household energy.

The index for all items less food and energy was unchanged in September, as it was in August. The
shelter index was unchanged for the second month in a row. The indexes for apparel, household
furnishing and operations, recreation, and used cars and trucks all declined in September, offsetting a
sharp increase in the index for medical care and a slight increase in the index for new vehicles.

Over the last 12 months, the index for all items less food and energy rose 0.8 percent, the lowest 12-
month increase since March 1961, with the shelter component down 0.4 percent. The food index rose
1.4 percent, with both the food at home index and food away from home index rising the same 1.4
percent. The energy index rose 3.8 percent over the last year, with gasoline up 5.1 percent.

One Eye on the Fed: FOMC Minutes for Sept 21, 2010

The Fed today released the minutes from their last meeting on Sept 21. The minutes describe who attended the meeting, their fact finding observations and their conclusions. Here is a link to the FOMC Meeting minutes. The information reviewed at the September 21 meeting indicated that the pace of the economic expansion slowed in recent months and that inflation remained low.

Monetary policy is the primary tool at their discretion. They use it to accomplish the goal of  a sustained expansion, described by Bernanke in his Jackson Hole speech as "growth in private final demand--notably, consumer spending and business fixed investment." He went on to describe his outlook for consumer and business spending. "Despite the weaker data seen recently, the preconditions for a pickup in growth in 2011 appear to remain in place. Monetary policy remains very accommodative, and financial conditions have become more supportive of growth, in part because a concerted effort by policymakers in Europe has reduced fears related to sovereign debts and the banking system there. Banks are improving their balance sheets and appear more willing to lend. Consumers are reducing their debt and building savings, returning household wealth-to-income ratios near to longer-term historical norms. Stronger household finances, rising incomes, and some easing of credit conditions will provide the basis for more-rapid growth in household spending next year."

"Businesses' investment in equipment and software should continue to grow at a healthy pace in the coming year, driven by rising demand for products and services, the continuing need to replace or update existing equipment, strong corporate balance sheets, and the low cost of financing, at least for those firms with access to public capital markets. Rising sales and increased business confidence should also lead firms to expand payrolls. However, investment in structures will likely remain weak. On the fiscal front, state and local governments continue to be under pressure; but with tax receipts showing signs of recovery, their spending should decline less rapidly than it has in the past few years. Federal fiscal stimulus seems set to continue to fade but likely not so quickly as to derail growth in coming quarters."

Market Data: Week Ending October 8, 2010

Market Index	2009 Close	10/8 Close	Week Change	Simple YTD %
Dow Industrials Avg	10428.05	11,006.48	1.63%	5.55%
S&P 500	1115.1	1,165.15	1.65%	4.30%
Fed Funds Rate	0.25%	0.21%	0.01%	0%
10 yr T-note Yld	3.85%	2.39%	-0.12%	-1.46%
5 yr T-note Yld		1.10%	-0.16%
5 yr infl adj Note		-0.47%	-0.28%
Implied 5 yr Inflation %		1.57%	0.12%
2 yr T-note Yld	1.14%	0.34%	-0.07%	-0.80%
2-10 Yr Slope	2.70%	2.05%	-0.05%	-0.65%
90 day T-bill Yld		0.11%	-0.04%
Gold ($/oz)	$1,096.95	$1,345.30	2.04%	22.64%
WTI Oil ($/brl)	$79.36	$82.66	1.32%	4.16%
VIX "Worry Index"	21.68	20.71	-7.96%	4.47%
Credit Spreads		10/8 Close	Week Change
Inv Grade Credit Idx		4.17%	-0.12%
Low Grade Credit Idx		7.98%	-0.21%
Markit CDX Inv Grd Idx		98	-8.41%
Markit CDX Mid Grd Idx		157	-7.65%

Sitting on a Signal

The Fed last met to discuss the condition of the economy on Sept 21. The U.S. central bankers said they were “prepared to provide additional accommodation if needed to support the economic recovery.” They also left the benchmark lending rate in a range of zero to 0.25 percent while noting that inflation measures were at levels “somewhat below” the central bank’s mandate to achieve stable prices and full employment. The Fed statement boosted speculation that the central bank will buy more Treasuries sometime later this year.

Fed observers/speculators are guessing that the FOMC will be announcing a new program of quantitative easing (QE) when they meet next on November 2-3. Some members of the FOMC are speaking about their need for evidence of trends that would threaten the Fed's mission of price stability (keep a lid on inflation) and full employment. Today they get the release from the BLS of the last employment data before the FOMC meets in early November. There is the suggestion is that a report indicating no, or little, improvement would support a new QE program announcement in November. Here is a brief look at the highlights. Payroll employment in September declined 95,000, following a revised 57,000 dip in August and a 66,000 decrease in July. The September fall was significantly more negative than the median forecast for an 8,000 decrease. But on the positive side, private nonfarm employment continued to rise, advancing 64,000 in September, following a revised increase of 93,000 the prior month. The median market forecast was for an 85,000 boost for private payrolls.

Fundamentally, toxic assets are still on the balance sheets of the TBTF banks in the US, UK and Europe. (See the second graph). The threat of a renewed crisis caused by the collapse of the global credit system is still a possibility. Banks are the lynch pin in our credit based world and they hold all the political cards too. Fundamentally, the continuing concern is that consumer and commercial lending do not recover with enough volume to contribute to a real economic recovery. That leaves the economy to look to the government for stimulus of some shape.

Federal Reserve Open Market Committee (FOMC)

As we get closer to the next meeting of the FOMC, on Nov 2-3, anticipation will be evident everywhere as the wait for their announcement describing the form of quantitative easing (QE) ends. The form it takes is possibly less important than if there will be another round of QE. Since it is widely anticipated already, there will likely be a negative reaction if the FOMC does not make some definitive statement of their intentions for using QE and the measures that convinced them to take that path. In the process of assembling this post, the structure of the Fed and the FOMC emerged and adds to the understanding of this integral organization. The next page is mostly information from the Federal Reserves web site, briefly describing the FOMC makeup and terms. Also, there are links to recent talks given by Fed Governors or Branch Presidents. In addition, there is a message regarding their personal opinion on QE being utilized again, taken from the talk linked by their name. Finally, there is a summary of the members current public position on QE, at the meeting in September when a vote was taken, and in the talks some have given since then.

Market Data: Week Ending October 1, 2010

Market Index	2009 Close	10/1 Close	Week Change	Simple YTD %
Dow Industrials Avg	10428.05	10,829.68	-0.28%	3.85%
S&P 500	1115.1	1,146.24	-0.21%	2.72%
Fed Funds Rate	0.25%	0.20%	-0.02%	0%
10 yr T-note Yld	3.85%	2.51%	-0.09%	-1.34%
5 yr T-note Yld		1.26%	-0.09%
5 yr infl adj Note		-0.19%	-0.21%
Implied 5 yr Inflation %		1.45%	0.12%
2 yr T-note Yld	1.14%	0.41%	-0.03%	-0.73%
2-10 Yr Slope	2.70%	2.10%	-0.06%	-0.60%
90 day T-bill Yld		0.15%	0.01%
Gold ($/oz)	$1,096.95	$1,317.80	1.49%	20.13%
WTI Oil ($/brl)	$79.36	$81.58	6.65%	2.80%
VIX "Worry Index"	21.68	22.5	3.64%	3.78%
Credit Spreads		10/1 Close	Week Change
Inv Grade Credit Idx		4.29%	-0.09%
Low Grade Credit Idx		8.19%	-0.13%
Markit CDX Inv Grd Idx		107	-6.14%
Markit CDX Mid Grd Idx		170	-2.86%

Median Home Cost in Terms of Gold as Money

Today's chart presents the median single-family home price divided by the price of one ounce of gold. This results in the home / gold ratio or the cost of the median single-family home in ounces of gold. For example, it currently takes 144 ounces of gold to buy the median single-family home. This is considerably less that the 601 ounces it took back in 2001. When priced in gold, the median single-family home is down 76% from its 2001 peak (to a level last seen in January 1983) and remains well within the confines of its six-year accelerated downtrend.

Scanner here: This chart is making the case for gold more clearly than the case of real prices still falling. But it is also saying that there is no question which one should be owned as an investment. Own a home for housing, decorate it with gold.