Friday, October 28, 2005

So, Besides in Energy, Where's Inflation?

By Campion Walsh and REBECCA CHRISTIE


...Within the advance GDP report, the personal consumption expenditures, or PCE, price gauge excluding food and energy rose 1.3% in the third quarter, down from 1.7% in the second quarter and well below the first quarter rate of 2.4%. Federal Reserve policymakers closely watch the core PCE as an inflation indicator...

By Campion Walsh and Rebecca Christie; Dow Jones Newswires

Inflation is decelerating, not accelerating. Remind me again why the fear of it is rising? Is filling up the tank once or twice a week really having that much of an impact on the psyche? (by the way, premium gas cost me $3.35 a gallon about six weeks ago and it's $2.80 today.)

Ten-year Treasury investors seem to believe that inflation is under control based on the prices they pay and the yield they are willing to accept. Low long-term rates are good for economic growth in most cases. There is one scenario, however, that low long-term rates will not boost the economy: When short-term rates rise enough to make the yield curve flat or inverted, banks have little incentive to lend and capital providers have little incentive to provide capital. That leads to slower growth.

The Fed's action to increase short-term rates, while long-bond investors keep long-term rates low, has flattened the yield curve. Given the diminishing evidence of core inflation, the Fed runs the risk of causing a recession. Then, inflation will be last on everyones' list of fears.

Wednesday, October 26, 2005

Time to Short Papa John's (PZZA)?

On Mondays during football season Papa John's Pizza offers one free topping to pizza buyers in the Washington, DC area for every touchdown the Redskins score, and they double that if the Redskins win. This Sunday the Redskins scored SEVEN touchdowns and won. Pizza buyers got FOURTEEN free toppings.

From the Washington Post: apparently was brisk. One deliveryman brought 20 pizzas to Redskins Park and said: "We're getting slammed today. . . . Everybody's happy."

Given that the Redskins are second in the entire NFL in offense, their quarterback--Brunell--is the top rated passer in the NFC, their top rusher is fourth in the NFC and their top receiver is on pace for 2,000 yards in receiving, which will blow away Jerry Rice's single-season receiving yards record of 1,848, it might be time to short the stock. Pizza margins are ridiculously thin and I've got a hunch that the amount of meat on Monday's pizzas could have fed a city in China for a month. And, think of the worker's compenastion suits when the delivery folks try to carry 50-pound pizzas.

Friday, October 21, 2005

Results of Fed's Hawkish Comments

From Dow Jones Newswire's Market Talk

12:03 (Dow Jones) Recent comments by a revolving door of Fed officials have crushed stocks and investors' confidence. But they're doing exactly as they should, says Kent Engelke, capital markets strategist at Anderson & Strudwick. The Federal Reserve cannot be complacent and the moment it declares inflation as a non-factor it reappears," Engelke says. "Moreover it must continually repeat its inflation mantra to rationalize its actions even as the economy appears sluggish by some data points."

Exactly what I said eight days ago. Despite all of the talk of inflation, the ten-year is rallying strong today and driving the yield down to 4.39%. The yield curve is also flattening, which will put pressure on bank NIMs.

Wednesday, October 19, 2005

The Best Line I've Heard on an Earnings Call

Chad Dreier, the CEO of The Ryland Group--a large, national homebuilder--presented RYL's third-quarter earnings on a conference call.

An analyst from Ram Partners commented that he perceived some frustration in Chad's voice about the decline in RYL's stock price despite the great results that the company has produced this quarter and in the past five years. Chad said it was like:

"I offered you Cindy Crawford and you complained about her mole."

Thursday, October 13, 2005

The Current State of the US Equity Market

Three things drive equity market returns: Earnings, interest rates, and risk.

When I refer to earnings I mean economic earnings, or what Buffet calls “Owner’s Earnings,” which is the cash flow left over after paying all obligations including the cost to replace the capital equipment used to generate those earnings. GAAP earnings are often illusory.

Interest rates impact the market because they influence the discount rate that an equity investor will use to calculate the present value of his expected earnings. Equity investors use a discount rate that is acceptable to compensate them for investing in risky assets like stocks. As rates on risk-free Treasuries rise, so will the discount rate because the risk-free rate is an opportunity cost. Likewise, the discount rate will increase when risk increases. As the discount rate rises, the present value of a stock’s earnings decreases and the price an investor will pay for equities declines.

Well, the market has not done well lately and it’s not because earnings have been disappointing. In general, earnings have been pretty good and growing. In fact, some of the most beat up industries like home building have reported or are expected to report continued double-digit growth in earnings compared with this time last year. So, that leaves interest rates and risk as the culprits.

The stock market has been beaten up recently because of inflation fears. Those fears have been fanned by the many remarks by employees of the Federal Reserve Bank over the past two weeks. Inflation, if it ever shows up, will force long bond prices down and interest rates up. So far, though, inflation is not showing up outside of energy prices. Yes, the PCE deflator, which the Fed closely follows, has risen to the top of the Fed’s “comfort range,” but the top of its comfort range is two percent; not a rate that gets too many people overly excited.

In fact, long bond investors have been so comforted by the Fed’s paranoia about inflation that they have bid long bond prices up and lowered long-term rates; the ten-year treasury is trading at 4.47% today and it was 4.60% over six months ago. It even fell below 4% recently. Ostensibly, long bond investors think that inflation is under control and I agree with them.

As for energy prices, we’ll adapt as long as we are free to pursue alternatives. We adapted after the OPEC shocks of the 1970s by drilling in the North Sea, Mexico and Venezuela and building a pipeline in Alaska. We’ll adapt today by finally drawing from the second biggest deposit of fossil fuels in the world in western Canada. And, maybe the Kyoto Krazies will back off and make it easier for Anwar to be developed when they realize that their Priuses still cost a lot to fill when gas is $4 a gallon.

The perceived risk, however, has increased. Volatility in equity prices has risen in the past month after being exceptionally low for most of the past year. If equity volatility has risen because of the comments coming from the Fed about inflation as I suspect, and that inflation does not materialize, I expect a large market rally. Rates will not go up as currently feared, and the perceived risk will decline. Earnings are not the problem.

Shut Up and Invest

HedgeWorld has devoted its entire September 2005 issue of Accredited Investor Magazine to hedge fund philanthropy. HedgeWorld writes that hedge fund managers are spending an increasing amount of their time and money on doing good deeds.

Although good public relations might come from philanthropy if the manager lets everyone know about it, clearly there is an opportunity cost associated with it. The time and money a manager spends on philanthropy takes away from the time and money he would spend making money for his investors. I would rather my hedge fund manager spend all of his time and money making money for me so that I could donate to whom I please. I would hate to invest in a George Soros fund, for example, only to have him donate my forgone investment returns to another wasteful project like

The analogy to this is transfer payments from federal and state governments. Governments tax us and decide which of the underprivileged are eligible for their welfare programs, which retirees are eligible for their social security programs, and which patients are eligible for their Medicare programs. Because paperwork gets pushed around by literally hundreds-of-thousands of bureaucrats, much of the money gets sucked down a giant drain, and that is before factoring in the lost productivity because private-sector providers of these services, such as doctors who take Medicare, have to adhere to monolithic, uncompetitive, bureaucratic standards. Virtually all of us would have been much better off if the government let us keep these payments and let us decide for ourselves. The few that are incapable of making decisions would easily be cared for by private charities that would be awash with funds because of a lower tax burden on donors.

Tuesday, October 11, 2005

Answer an Economics Question and Get Profiled

Test your understanding of economics and receive your “profile” from Alfred Winslow Jones Blogspot. ™

The Federal Reserve’s Open Market Committee released its September 20 meeting minutes today, in which it expressed concern about inflation. The committee said that Hurricane Katrina had added to “already considerable” inflationary pressures.

What is the primary reason that the hurricane has added to inflationary pressures? (Answer and scroll down for your profile.)

A. Business people are unethical and now can price gouge thanks to the cover provided by the hurricane?

B. Demand for labor and materials will increase in the rebuilding effort and all prices will increase because of it?

C. Productive resources were destroyed and productive human capital (know how) has been dislocated and the reduction of productivity will force prices higher?

D. All of the above

If you answered:

A: You are an idiot and a member of Greenpeace (wait, that’s redundant). You wear peace buttons and protest at Davos. You only drink Fair Trade coffee from Starbucks, but you switch cups so your friends will not find out that you patronize a capitalist establishment;

B: You are an economics professor who studied at an elite liberal university in the west. You bow down to the god Keynes, and dream about the day that you get to pull the economy’s levers in the next Democrat President’s Administration. Waiting for the day that the country wakes up and elects a Democrat is your incentive for living. You are also incorrect;

C. Congratulations! Skip graduate school and go straight to New Orleans, get rich, and remember your pal in New Jersey when you’re in Forbes;

D. You are very confused and probably forgot your meds;

Friday, October 07, 2005

Ah, It Is Getting Clearer...

Now I get it:

Release Date: December 21, 2004

For immediate release (From the Federal Reserve)

Richard W. Fisher will become President of the Federal Reserve Bank of Dallas effective April 4, 2005...

...In 1977, Mr. Fisher was "loaned out" by Brown Brothers to serve as Assistant to the Secretary of the Treasury during the Carter Administration, where he worked on issues related to the dollar crisis of 1978 and 1979..."

Fisher is overreacting to inflation today because he was partly responsible for the inflation debacle in the 1970s.

Why has Fisher Been in the Spotlight All Week?

NEW YORK -- Federal Reserve Bank of Dallas President Richard Fisher said Friday a stalled free trade agreement for the Americas is being tied up because of a lack of political leadership.

"Unless there is political willpower" coming from "economic necessity" and a "moral imperative," no free trade agreements will come to pass, Fisher told a conference at Baylor University in Waco, Texas. And that's what's stalled the Free Trade Area of the Americas agreement, Fisher said. "It's just not on the table right now," he said, explaining "we are not getting ... leadership from the very highest," both in the U.S. and in other countries involved in the process.

Fisher made no comments on monetary policy in his speech. In addresses earlier this week, he warned of his concerns about growing inflation pressures in the U.S. economy..."

By Michael S. Derby, Dow Jones Newswires

These comments eliminate him from consideration for Greenspan's job, so he must be looking for a book deal (see prior post). While I would love as many free-trade pacts as possible, the loony left and their Democrat friends in Congress are stalling this one. Fisher should reserve his ire for them.

Thursday, October 06, 2005

Shut Up and Bank

Richard Fisher, the President of the Federal Reserve Bank of Dallas (one of the twelve regional banks that make up our central banking system), must like the sound of his voice, especially when it resonates sensational sound bites that the main stream media can devour.

This week, Fisher gave two speeches that have been commented on by the MSM; one on Tuesday and one today. Usually, regional FRB Presidents operate in obscurity, and for good reason. That obscurity, it seems, has made Fisher lonely because he has taken to using the most outrageous language to warn about inflation and consequently bask in the media glow.

Today, when many sensational headlines warn about the potential for a flu pandemic like the one in 1918 that killed 50 million people, Fisher compared inflation with a flu virus that must be stopped at nearly all costs.

Today, when high gasoline prices have caused the economy to stutter and caused the MSM to write sensational headlines about the 1970s gas shortages, Fisher outrageously compared today’s economy with the US economy of the 1970s when inflation was rampant in all sectors, not just energy. Inflation was rampant because productivity did not exist. Productivity growth was eliminated in the 1970s because of two decades of demand-side management via high taxes, wage-price controls, and high government spending relative to GDP. There is very little to compare from that period and the current period and Fisher should know better.

So, why is he doing this? I can only think of three reasons:

1. He is trying to get a book deal;
2. He wants to be considered for Greenspan’s job and thinks being a fanatical inflation hawk is the only way he’ll get it;
3. He truly believes that our economy is similar to the economy of the 1970s;

I am going to give him the benefit of the doubt and say it’s either one or two above because if it’s number three, he is an ignoramus.

Fisher must know that outside of energy, inflation is running at about 2% per year. Does he know that the Consumer Price Index had a compound annual growth rate of almost 8-percent per year in the 1970s and in three of the ten-years it grew at double digits (1974: 12.3%; 1979: 13.3%; and 1980: 12.5%)?

The 1980s was a dream decade of low inflation and economic growth thanks in large part to the supply side policies of the Reagan Administration. Many who suffered through the 1970s (from the effects of bad policies put in place in the 1960s and 1970s) view the 1980s as a near miracle. The CPI this year (June to June) grew at a 2.99% rate. It averaged 4.72% in the miracle 1980s. That is, inflation is currently almost 37% lower than it was in the miracle decade. Fisher should know better.