Understated Inflation?

John Mauldin makes an excellent point regarding inflation perceptions in this week's Thoughts from the Frontline weekly e-letter. In short, consumers pay more attention to the items they buy more frequently and, currently, those are the items that are increasing in price the most.

[H]igh-frequency spending items like gasoline, food, education, and medical care make up 50% of the Consumer Price Index. These are items which we buy on a regular basis. And they are going up at a weighted average rate of 6.8%, a lot higher than the 4% for the CPI as a whole.

The 20% of the CPI which are low-frequency items like furniture, appliances, vehicles, and so on are actually falling at a -0.7% rate. Since OER (equivalent rent) is roughly 30% of CPI and is rising at 2.8%, even as home prices fall the overall rate is about 4%.

Our tendency to notice the price increases in more frequently purchased items more than the drop in less frequent expenditures is known as salience. What we see every day is more visible to us and is on our minds. And because the reality is that those prices are rising much faster than headline inflation, we tend to think inflation is understated.

More Upside to Come?

Quantifiable Edges has an interesting post regarding large gaps up in downtrends. Rob writes,

Buying gaps up of 0.75% or more during downtrends was actually profitable. In this case, 58% of the 105 instances finished with the SPY closing higher than it opened. The net total of the movement from open to close was a gain of about 26%...

I suspect short-covering is a big reason that large gaps tend to spark additional buying in downtrends but not in uptrends. Stops get blown through overnight and when they see the market getting away from them, panic-covering ensues.

The Nasdaq gapped up more than 1% today. If there is indeed more upside to come, I would be surprised if the Nasdaq Composite can sustain prices above the top of the 3-month trading range around 2,400.

Last Bank Standing

My wife has started a home-based business and we've been looking for the best bank to open a business checking account. Today I ask a friend if he knows which institution would provide the best service and he replies,

"If you wait a bit you'll probably only have one left to choose from :)"

That had me laughing to myself for a good 5 minutes... and I'm sure I will continue to chuckle about it the rest of the day. I hope you get half the entertainment out of it that I did.

Moral Hazard, the Federal Reserve, and Solvency

Yesterday's Outside The Box by John Mauldin provides an overview of the NY Fed's actions around Bear Sterns, along with commentary on the current "credit" crisis.

This is not a bailout. The shareholders at Bear have been essentially wiped out. Note that a third of the shares of Bear were owned by Bear employees. Many of them have seen a lifetime of work and savings wiped out, and their jobs may be at risk, even if they had no connection with the actual events which caused the crisis at Bear. Don't tell them there was no moral hazard.

...

The Fed is taking $30 billion dollars in a variety of assets. They may ultimately take a loss of a few billion dollars over time, although they may actually make a profit. When you look at the assets, much of it is in paper that will likely get close to par over time, and the good paper will pay premiums mitigating the potential loss. The problem is, as the essays below point out, no one is prepared to take that risk today.

- John Mauldin, Editor: Outside the Box

John correctly points out that the NY Fed's actions will not create a moral hazard problem. Bear shareholders lost 90% of their equity from Friday's close, after Bear closed down ~50% from Thursday.

He also notes taxpayers won't likely be stuck with a huge bill. The Fed is doing exactly what its supposed to - act as a lender of last resort. Perhaps they're following the cliche, "buy when there's blood in the streets." I think that characterizes the current state of the credit markets pretty well.

What may be lost in the excitement of the moment, as markets attempt to digest these latest actions, is that were taken by the Board of Governors through the Federal Reserve Bank of NY to address issues of financial stability. These were NOT actions taken by the Federal Open Market Committee (FOMC). Their main responsibility is the conduct of monetary policy for the country.

...

It is time to step back and recognize that the current situation isn't a liquidity issue and hasn't been for some time now. Rather there is uncertainty about the underlying quality of assets which is a solvency issue driven by a breakdown in highly leveraged positions. Many of the special purpose entities and vehicles are comprised of pyramids of paper assets supported by leverage whose values are now unknown.
- Bob Eisenbeis, Cumberland Advisors

These two paragraphs by Mr. Eisenbeis make an essential point that some continue to miss: this is not a liquidity issue. As he notes, these actions were not taken by the FOMC to address a monetary policy issue.

January Inflation Reports

The inflation numbers for another month are in, and the results do not look very good. The charts and brief commentary below summarize the changes.

Today Calculated Risk noted that, "inflation expectation have surged recently." They cite a Bloomberg article that charts the spread between the 5-year TIPS and the 5-year Treasury. You can find an interactive chart of the spread between those two rates on the Cleveland Fed's website.

At this point, I think it's safe to say that - contrary to what the FOMC has to say - both inflation and inflation expectations are not well contained.

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Annual core PPI inflation has moved from its 2006 lows near 1% to hovering above 2% in the second half of 2007.

Core PCE inflation has jumped back above 2% and trimmed-mean PCE inflation is nearing 2.5%.

CPI inflation is worst of all; core is near 2.75%, 16% trimmed-mean is approaching 3%, and the median CPI is closing on 3.25%.

Countrywide Insurance

Countrywide services my mortgage. Don't worry, I'm not going to default or walk away from my mortgage...

The newest solicitation I've received from them is an application to insure my 'major home appliances or systems'. This seems like a desperate grab for high-margin cash. However, does Countrywide really want people to potentially have to choose between paying their mortgage and paying their appliance insurance premiums?

For only $37.95 per month, conveniently collected with your mortgage payment, you can have the security of knowing that your broken appliance will be replaced.* Imagine... a whole new furnace costing no more than your $60 deductible.*

Here are my favorite examples of items for which the policy includes repairs and replacement:

• Garbage Disposal (This is so essential!!!)
  
• Ceiling Fan (These are $100, maybe $200?)
  
• Electrical / Heating / Plumbing Systems (All of it?!?!?)
  

My other favorite are the pictures of people who 'GAMBLED AND LOST'.

• Thought his furnace would last another year. GAMBLED AND LOST $4,208
• Thought he had the perfect oven. GAMBLED AND LOST $1,486
• Thought their freezer would star frosty. GAMBLED AND LOST $1,023

Yes, instead of gambling and losing, you can ensure a $480+ loss each year plus your deductible each time something happens to break. I'll take two! Maybe they just want to suck as much money away from their customers before they walk away or default on their mortgage?

* This represents the best case scenario. You will probably get hosed for much more.

Wikipedia Errors

Wikipedia has been said to have fewer errors than Encyclopedia Britannica but, as one of my co-workers said, "I bet Encyclopedia Britannica doesn't have errors like this!"


I stumbled on this as I was surfing the web this morning. I was searching for ideas of potential names for a new R bundle I'm working on. It literally made me laugh out loud.

UPDATE: I think my previous image was deleted because of the 'content'. Here's the image, censored. And yes, it's a four letter word; but you can say it on television... I guess just not in front of those two words (I'm not sure what the phrase means).