Market Data: Week Ending December 24, 2010

Market Index	2009   Close	12/24  Close	Week Change	Simple YTD %
Dow Industrials Avg	10428.05	11,573.50	0.71%	10.98%
S&P 500	1115.1	1,256.77	1.03%	11.27%
Fed Funds Rate	0.25%	0.21%	-0.01%	-19.05%
10 yr T-note Yld	3.85%	3.39%	0.06%	-13.57%
5 yr T-note Yld		2.06%	0.11%
5 yr TIPS - 'Real' Yld		-0.01%	-0.02%
Implied 5 yr Inflation %		2.07%	0.13%
2 yr T-note Yld	1.14%	0.65%	0.04%	-0.49%
2-10 Yr Slope	2.70%	2.74%	0.02%	0.04%
90 day T-bill Yld		0.13%	0.03%
Gold ($/oz)	$1,096.95	$1,380.50	0.09%	25.85%
WTI Oil ($/brl)	$79.36	$91.51	3.97%	15.31%
VIX "Worry Index"	21.68	16.47	2.23%	-24.03%
Credit Spreads		12/24  Close	Week Change
Inv Grade Credit Idx		4.83%	-0.03%
Low Grade Credit Idx		8.36%	-0.03%
Markit CDX Inv Grd Idx		86	0.00%
Markit CDX Mid Grd Idx		132	-2.22%

Inflation Forecasting

Two economic analysts at the Cleveland Fed published their article earlier this month on the Banks web site. Brent H. Meyer and Mehmet Pasaogullari wrote Simple Ways to Forecast Inflation: What Works Best?. For this article, they investigate a few simple statistical models to forecast Consumer Price Index (CPI) inflation, along with some even-simpler rules of thumb. They investigate two readily available survey measures of one-year-ahead inflation expectations, the median expectation from the University of Michigan’s Survey of Consumers (UM) and the median expectation for CPI inflation from the Federal Reserve Bank of Philadelphia’s Survey of Professional Forecasters (SPF).

These measures are intriguing as forecasting tools, as it is highly plausible that, given wage and price stickiness, individuals embed expectations of future inflation into their price-setting and decision-making behavior today. In fact, if you’ve read or listened to a Federal Reserve official lately, chances are you’ve probably heard something to the effect of “inflation expectations matter.” Indeed, central bankers’ sensitivity to inflation expectations seems warranted, as it is theoretically possible that expectations can be self-fulfilling prophecies. However, we are mainly interested in the forecasting properties of these measures here.

They conclude that there is no standout method. They were impressed with the ability of 'inflation expectations' to accurately anticipate the correct level of inflation. Specifically, they noticed that measurements of inflation expectation such as the UM survey and the Philly Fed's SPF, mentioned earlier, produced forecasts that were more accurate than most of the statistically based models they investigated.

Please, Just Lie to Me! A Lesson on Financial Cognitive Dissonance

First contributed by: Anonymous, aka: Curious George on 12/1/2009

What is cognitive dissonance?
Anxiety that results from simultaneously holding contradictory or otherwise incompatible attitudes, beliefs, or the like, as when one likes a person but disapproves strongly of one of his or her habits. (Dictionary.com)

It’s not so much the definition of cognitive dissonance but rather how we respond to it that is important. If investment decisions are built on untruths, results will suffer. Every day we are presented with conflicting information and we are conflicted in what to believe. If one wants good investment results then good information really does matter. So, where is the truth?

Social psychologist Leon Festinger says “Dissonance and consonance are relations among cognitions that is, among opinions, beliefs, knowledge of the environment, and knowledge of one's own actions and feelings. Two opinions, or beliefs, or items of knowledge are dissonant with each other if they do not fit together; that is, if they are inconsistent, or if, considering only the particular two items, one does not follow from the other” (Leon Festinger 1956: 25).

His three ways of dealing with cognitive dissonance
1. One may try to change one or more of the beliefs, opinions, or behaviors involved in the dissonance;

Market Data: Week Ending, December 17, 2010

Market Index	2009  Close	12/17  Close	Week Change	Simple YTD %
Dow Industrials Avg	10428.05	11,491.90	0.72%	10.20%
S&P 500	1115.1	1,243.91	0.28%	10.36%
Fed Funds Rate	0.25%	0.22%	0.04%	-13.64%
10 yr T-note Yld	3.85%	3.33%	0.01%	-15.62%
5 yr T-note Yld		1.95%	-0.03%
5 yr TIPS - 'Real' Yld		0.01%	-0.13%
Implied 5 yr Inflation %		1.94%	0.10%
2 yr T-note Yld	1.14%	0.61%	-0.03%	-0.53%
2-10 Yr Slope	2.70%	2.72%	0.04%	0.02%
90 day T-bill Yld		0.10%	-0.02%
Gold ($/oz)	$1,096.95	$1,379.20	-1.14%	25.73%
WTI Oil ($/brl)	$79.36	$88.02	0.26%	10.91%
VIX "Worry Index"	21.68	16.11	-8.52%	-25.69%
Credit Spreads		12/17  Close	Week Change
Inv Grade Credit Idx		4.86%	0.06%
Low Grade Credit Idx		8.39%	0.08%
Markit CDX Inv Grd Idx		86	-2.27%
Markit CDX Mid Grd Idx		135	-1.46%

November 2010 Consumer Price Index

The Consumer Price Index for All Urban Consumers (CPI-U) increased 0.1 percent in November 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.

The indexes for food, energy, and all items less food and energy all increased slightly in November. The
index for food at home rose in November after being unchanged in October, with the indexes for eggs
and nonalcoholic beverages both rising notably. Although the index for gasoline rose, the index for
household energy declined and the increase in the energy index was the smallest in five months.

The index for all items less food and energy rose in November after being unchanged the previous three
months. Increases in the indexes for shelter and airline fares accounted for most of the rise, while the
indexes for new vehicles, used cars and trucks, and household furnishings and operations all declined.

Over the last 12 months, the index for all items less food and energy has risen 0.8 percent. The energy
index has risen 3.9 percent over that span with the gasoline index up 7.3 percent but the household
energy index down 0.2 percent. The food index has risen 1.5 percent, with the food at home index up 1.7
percent.

Here is a link to the entire release from the BLS.