More trouble for the U.S. Dollar?

Recently, the FED has substantially cut rates in response to the growing recession fears that have spread into the minds of more academics and economists. Although the possibility of a recession is no small matter, the FED has seemingly ignored another major problem facing our economy and financial well-being.

Our US Dollar has resumed its downfall against other major world currencies, most importantly the Yen and Euro. After a mid-December rally, the USD has plunged to new lows again compared against both currencies. Despite a global credit crunch and recession worries in Asia and Europe, the FED typically acts most rapidly and decisively when problems arise. On this positive note, we can expect the other central banks to begin cutting rates sometime later in the year as a more reactionary measure instead of a combination between reaction and precaution. Asian growth is still expected to maintain, but interest rates have risen to unhealthy levels. Meanwhile, Europe seems a few months behind the US economy in the GDP cycle, so slower growth may not be realized until the late 3rd or early 4th quarter of this year.





One solution to the falling value of the Dollar the FED has yet to utilize is the mop up of excess money floating around throughout the economy. Unfortunately for the US central banking arm, excess liquidity has been necessary in a marketplace stricken with tightening credit standards and loan requirements. As the financial sector continues to right itself (with the help of much needed investment from the private sector and abroad), the FED may begin to start diminishing some of this exorbitant amount of dollars. Hence, less supply will help drive the USD's value back in the right direction.

Stocks will push for another bullish end to the year

With so much controversy and turmoil in the marketplace in 2007, it seems only fitting that a prediction of bullishness is viewed skeptically by many in the investment world. However, I believe there are several factors that will continue to churn out new records in most equity sectors and classes.

Recent stock market pull-backs have been caused mainly by rising interest rates. Bond Yields rose again on Thursday bringing rates to around 5.17%. Despite the substantial increase of 400 basis points, the equity markets finished higher due to some good economic data. Although bond yields pose a short-term threat to the markets, they can only do so much damage before the flood of capital and investor confidence takes over.

Looking at the 10-yr bond yield (considered one of the best measures of rates), it continues to approach the target Federal Funds rate level. But what is going to happen when bond prices become just a few hundred basis points away from the target interest rate? They will halt, quickly. In other words, the upside to the stock market far outweighs the potential rise in bond yields. Therefore, if bond rates are not going to get much higher, we must assume that housing will begin to stabilize during the latter half of the year. In addition, consumer and institutional confidence should continue to increase providing higher highs in the marketplace.

Another key aspect of the interest rate impact regards the flattening of the yield curve. One of the main arguments of the bearish analysts on Wall Street this year has been the inverted yield curve. Not only has the curve flattened, it has really begun to shape back to its normal progression, with yields correlating to the length of the investment. Stabilization of interest rates and normal payout percentages will make short term bonds more unattractive and simultaneously display equities as a prime target for even larger amounts of capital.

Stocks remain undervalued when taking into account global profits, revenue and earnings growth, higher margins, and currency conversions. Now might be the time to buy, not sell.

Another big sell-off, but was it healthy?

As US economic growth wavered in Q1, coupled with a few big sell-offs in the equities markets, stocks steadfastly rebounded and repeatedly approached new record highs. Taking into account the vast amount of negative numbers regarding economic data, equity prices fearlessly drove higher, despite predictions by several top economists and market analysts that a recession was near. A key basis point of these bears centered around the inverted yield curve, a unique phenomenon which has been succeeded by a recession every time it develops.

Low and behold, several months and vastly higher heights later, another pair of significant sell-offs occurred. This time however, these bears are missing a significant piece to their pessimistic puzzle. Finally, after years of mismanagement by the FED and US Treasury Dept., the yield curve has begun to normalized. The inversion has reversed, as long-term treasury yields have overtaken the 90-day T-bill rates.



Another issue the bears seemed to dwell on regarded weakness in the US Dollar. Many argued that global equity markets would continue to prosper while US stocks would take a significant hit because of the weakness in profitability between exchanges in currency rates relating to asset levels and market capitalization. Unfortunately, these bears failed to realize the global impact and success of American companies abroad. Giants such as General Electric, United Technologies, and Boeing continue to impress and solidify market share across the globe. Therefore, these revenues made abroad will translate high relative to the USD, failing to impact corporation's balance sheets like pessimists believed they would. In addition, the Dollar has continued to climb against the Yen and made a good comeback against the Euro recently.

Therefore, don't expect a large correction over 5-6% anytime in the near future. The US economy is going strong and stock slumps are supposed to be caused by Bond yield inflation, not computer glitches. This is a natural cycle and valuations are still appealing in the equity markets.

Are Biofuels contributing to inflation in the U.S.?

With the steady rise of demand for biofuels due to subsidies and governement regulations, displacement of crops may lead to higher inflation in food prices. According to Shane Romig of the Associate Press, Argentines are not all happy about the government's new ethanol/bio-diesel plan.

Although few would argue against the environmental benefits of ethanol and other crop-based fuels, economic feasibility has long been in question. This article makes an important point in that diversion of crops towards fuel will likely lead to higher food prices. Despite vast differences in wealth, Americans in the lower and bottom middle-class could possibly face drastic changes to their food purchasing habits.

This may go a long way to show that hydrogen fuel-cell and other alternative means such as batteries may ultimately replace Ethanol as the mobile energy for the future.

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Protectionism is a double-edged sword

Sen. Hilary Clinton continues to lead the protectionist rampage on the political front, she has yet to provide any hints as to her solutions to the various problems that are certain to arise should she win and enact her regulations. Protectionism has both positive and negative effects, the later of which Clinton ignores.

I doubt anyone questions the concern over the amount of outsourcing that has taken place since the early 1990s. Something needs to be done to revitalize the US economy, that isn't debatable. The methods for achieving the end means is where politicians and economists seem to differ.

Clinton tends to suggest that Protectionism will help keep jobs inside of US borders, lower the trade deficit and ultimately act beneficial to the overall economic well-being. She doesn't seem to realize that the trade deficit has no net affect on the United States. Entities and people trade, not countries. She should be more focused on U.S. GDP Growth rates because various factors influence trade, including tariffs, tax rates in respective countries and currency conversion rates.

If you look at Hilary's plan, implementing policies to force companies and Americans to buy home-grown products will certainly result in significant spikes in inflation. She doesn't seem to have any grasp of this concept. If strong tariffs or other protective measures are enacted, those goods that will be then produced by workers in America will most definitely be higher in price due to the wage and benefits difference.

Another key consequence on protectionism is a stronger US Dollar. Although some argue that would be beneficial for the United States and her citizens, this would only hold true when trading or converting currency or wealth with other countries. An inflated currency has proven to be part of the problem with outsourcing because a higher USD makes foreign imports cost less and become more attractive. This is a central factor in the massive import problem the US faces. Should the USD fall relative to the Asian currencies, which it still has yet to do, demand for US exports will rise dramatically.

The double edge sword comes into affect if the US Dollar were to fall too quickly, lowering the value of personal wealth and ultimately creating inflation simultaneously. By any means, the situation is complex and fragile, something Sen. Clinton needs to realize soon.

To be or not to be...Protectionist

There is a very fine line for the subject and cringe at those who believe it should be one extreme or the other. Senator Clinton has already established herself as a major protectionist, but I wonder what the other candidates stances are on this issue. If Clinton continues on this rampage, she will certainly alienate conservative or pro-business, pro-market Democrats as well as Republicans. During this time of economic prosperity and concerns over whether it will last, she might play herself into a defeat during the Democratic Primary.

With global trade and economic dependence, protectionism will be a key issue in the economic debates for both the primary and general elections. I'm interested to see how big pro-Wall Street politicians like Giuliani feel about this subject. Giuliani is by far the best candidate for Wall Street, or so those who work there believe. His extensive background in business and business law should certainly aid him throughout the Republican Primary. Whether the financial outlook looks bleak or solid, he can use his vast experience to persuade voters that his economic policy will either strengthen or maintain the future.

Whichever party wins, I hope Congress and the financial and economic experts in their cabinet and in key organizations (FED, FOMC, etc.) deter any candidate from going one way or the other. Too much protectionism, such as Sen. Clinton is proposing, will create a steep increase in inflation, decrease US exports as well as imports, and put a significant strain on our diplomatic relationships around the globe. By the same token, failure to create and maintain low-wage jobs will also create economic and social problems such as high unemployment and more dependence on government welfare and tax dollars. Additionally, Wal-Marts will continue to force their suppliers to venture outside of the US to keep up with the low prices they demand, directly affecting the job market.

Protectionism is a touchy subject, one that will not become any easier to figure out as the US economy becomes more reliant on globalization. Creating a limited protectionist platform sounds like the most effective route to counter this problem. Although it will create subjectivity, most who follow the economy can agree that neither extreme would ultimately be beneficial for America. Free trade needs to be emphasized, but some low taxes can offset enough jobs from being sent overseas.

Good numbers for the U.S. Economy

More good numbers came out today, suggesting a recession is not likely in the near term for the United States economy like some economists such as Paul Krugman and Barry Ritholz. Let's start with the bad numbers.

Pending Home Sales came in at -4.9% against projections of 0.4% increase due to spring buying habits. Part of this number may be due to the cold snaps felt throughout the early part of the spring. I wouldn't be surprised to see that number rally this month.

Now on to the good news. The ISM Manufacturing Index rose to 54.7%, a new 52-week high. With the good manufacturing numbers came a sharp decline in bond rates, a move that will help support the stock market's rally.
Source: Marketwatch

Yesterday several strong numbers came out including personal income and DPI, each rose by 0.7%. Improvement in income leads to higher consumer spending and eventually GDP growth, corporate profits and a bullish stock market. The PCE inflation measure was flat, signaling slowing inflation. This is key considering inflationary worries and concern over the FED hiking rates if inflation maintains high levels. Gold prices also dipped, strengthening the dollar and lowering commodity prices.

The US is jealous of the French economy and lifestyle?

Although I find this laughable, bonehead NY Times Columnist Paul Krugman believes otherwise.

This is the same Paul Krugman who is predicting a massive recession. Please, Paul, for humor's sake, let's compare the U.S. to France.

GDP : US - $12.455 Trillion , France - $2.126 Trillion according to the IMF

If you take into account Purchasing Power Parity (PPP), the US is around $12.229 Trillion compared to France's $1.835.

Unemployment : US - 4.4%, France - 8.4%

Krugman is certainly a smart man. You don't go to the schools he attended if you aren't a bright guy. Somewhere along the line though, he was misguided and his economics and sense of what Americans want or feel seems to be way off. He continues to be a pessimist in the current economy while the U.S. outperforms France year after year.

China learning well from U.S. Economists

As one of the fastest growing economies in the world and one of the largest, China could easily be arrogant, unresponsive and even disrepectful to the U.S., a former Cold War nemesis. That does not seem to be the case however, considering the trend of decisions made by the Chinese version of the FED, with counsel from U.S. bankers and economists.

The Wall Street Journal reported today that China lifted bank reserves in an attempt to help control growth. Although growth in double digits seems very appealing to most investors, the Chinese Central Bank and U.S. economists realize it may actually pose a huge recession threat down the road. With a lesson learned from the U.S. housing bubble, created by Alan Greenspan's flawed monetary policy, China is attempting to prepare itself and provide a soft-landing to the world's second largest economy (GDP using PPP).

Though the graph suggests no recession problems, you can be sure that growth will be tough to sustain at such a high rate. If China can curb its growth now at 8-9%, it will be able to sustain it for a much longer period of time with less volatility, such as the graph suggests. However, if they continue growing by double digits, the threat of a bubble burst is likely, one that could ultimately ruin the economy or set Chinese progress back severeal years.

Economic Worries for the U.S. Economy

Despite weak GDP performance in the first quarter of 2008, the equity markets continued their climb today with the Dow closing at yet another record high. All of this came amidst talk of a potential recession, a weak Dollar, and declining markets abroad. With this seemingly unstoppable run continuing, there are still several factors that worry me about the current economy.

First off, let me make it crystal clear that I am still Bullish on the stock market and economy in the long run. However, there are too many factors signaling a struggle ahead. Lets begin with the inflationary pressure on the economy. The CPI and PCE both rose to suggest higher prices across the broad economy. Although prices in commodities continue to increase, I do not see these increases in the CPI and PCE repeating themselves for more then a few months. Commodity prices are being driven by international demand and growth, not domestic. Therefore, rising commodity costs are not being translated into actual inflation for most ordinary Americans except in the form of gasoline.

Another concern I have relates to the Fed's competence and the inverted yield curve it created. Greenspan is out, so I will wait to see how Bernake handles a fragile situation. Many bears argue we have never seen an inverted yield curve without a recession following. This fact is entirely accurate, yet may not be in this unique situation. The Fed mishandled rates in 2002-3 by sending them too low, creating the massive housing boom. Without properly limiting growth and speculation in the housing sector, the expected happened in when the bubble burst. Sub-prime spillover and sharp declines in housing prices and sales are not what worries me though. The drastic lowering of interest rates was overdone compared to inflation numbers. Additionally, it hurt the USD, which dropped steeply between 2002-4.



In an attempt to try and generate a perception of normal inflation, the Fed has increased the amount of money it prints to provide a short-term wealth. This will only worsen inflation in the long run as prices of goods and service remain constant the value of the dollar drops even more. To help control inflation, the Fed keeps focusing on raising the short-term FF rate instead of both the short and long or just the long. This has created the inverted yield curve, which undervalues long-term lending. Why would anyone borrow for the long term when they can get short-term returns at higher rates? Not to mention, it makes the U.S. pay back larger debts sooner rather then later.

Lastly, corporate profit records of late have been derived from operations abroad, not domestically. These profits are good since the companies making them are many of those headquartered in America. But, the income and revenues being attained globablly does not help our economy in terms of GDP, employment, and other factors. When you consider most of the returns on the investments made internationally stay outside the U.S. boarders, it really has no net affect on our country except for aiding to drive the equity markets higher. Also, if you consider the gains of the Euro and Pound against the USD, it makes sense that these companies continue to report record earnings. It must be near impossible for Wall Street to predict income and revenues generate across the world, let alone exchange rates to translate those earnings and sales.

These are just some things to consider in the short-term. Once GDP growth heads back towards 3-4% in the 4th Quarter, you can be assured that a new big rally will begin. Unless, of course, the current rally just never dies. As Larry Kudlow says, "It's the greatest story never told" and I expect many Americans to continue to reap benefits of investing in stocks, mutual funds and ETFs.

Why the equity market is still the best play

Over long periods of time, nobody can argue that the equity markets always return higher yields then the bond market. Bonds are used because of their safety, but I would argue that anyone planning on investing over a 10-year period or more should just as well invest in stocks. Some argue, however, that high short-term yields present an adequate substitute for equities.

When you examine the current T-Bill yields, you find them extremely low. So what purpose would that give to invest in bonds? Looking at outside factors, you would realize that the USD has started to take back gains against the Yen, Euro and Pound. If you couple the gains in the Dollar with record high tax revenues, which in turn help decrease the deficit in the budget, Bonds would seem attractive because yields would continue to increase. However, as my fellow blogger Rufus quickly corrected himself, he explained, "Of course, the second act is the market explodes, again and the "bond" holders take a bath."

Therefore, even if the bond market rallies in the coming few months and stalls the equity boom, eventually the stock market will pull through and continue to mount significant gains. Some will argue that the spread between bond yields and commodities is too vast and one or the other will increase or decrease, respectively. With inflationary pressure in the market beginning to wane, the odds are against a momentus rally in the fixed-income market. From this, you can predict that commodity prices will slide some, although with global growth and demand as strong as it is, a larger then normal spread is not all that worrysome.