This morning’s U.S. inflation numbers are good news if you live in the alternative reality called the financial markets. However, if you live in the real world—you know the one where you buy things and have to make income and outgo match each month—the inflation news was remarkably bad.
The headline consumer price index climbed 0.7% in February. That’s the biggest jump in almost four years. It’s also a significant increase from January and December when headline inflation was flat. Economists had expected an increase of 0.5% for the month.
Core inflation, the number the Federal Reserve and financial markets watch, presented a much better picture. The core inflation rate, which excludes volatile food and energy costs, rose just 0.2% in February. That was actually a drop from the 0.3% increase in core inflation in January. The February core inflation number exactly matched expectations among economists surveyed by Briefing.com.
Why the big difference in the headline and core inflation rates? Two guesses—food or energy—and the first guess doesn’t count.
It sure wasn’t the result of soaring food prices. Food prices rose just 0.1% in February.
So it must have been energy, right? Yep, energy prices climbed 5.4% in February (after falling for three consecutive months) on a huge 9.1% increase in gasoline prices.
In financial world all this is reasonably good news. The core inflation measures the Fed watches showed no signs that core inflation might be on the upswing or that inflation expectations might be rising. Nothing in these numbers to suggest that the Federal Reserve, scheduled to meet next week, should consider ending its monthly $85 billion program of quantitative easing early. That’s especially true because the most likely explanation for the increase in gasoline prices—soaring prices for the credits that U.S. refineries buy so they don’t have to blend quite so much corn-based ethanol into their gasoline—can be passed off as a short-term technical problem.
On the other hand, in the real world, these inflation numbers are bad news. Read more
So now what?
We’ve had a December sell down on fears that the United States would go off the fiscal cliff—the Dow Jones Industrial Average was off 2.48% in the fourth quarter.
We’ve had a huge pre-New Year’s move—the Standard & Poor’s 500 Stock Index climbed 1.7% on December 31 on hopes that the crisis would get resolved and an even bigger January 2 move on an actual “solution. The total gain comes to 4.3% for the two sessions.
But where does the market go from here? I think you can guess, right? After all we did go through this pattern of sharp rallies and deep retreats in 2012.
So with the benefit of that experience, let me give you my seven steps for the first half of 2013. Read more
The topic of this post is simple: The value of cash in uncertainty.
You can guess what prompts it: the looming U.S. fiscal cliff.
And the uncertainties that accompany it.
Let’s count up those uncertainties and then take them apart a bit.
First uncertainty: Will Congress and the President strike a deal before the December 31 expiration of the Bush tax cuts, the lower Social Security withholding rate, and extended unemployment benefits and the beginning of automatic budget cuts?
Second uncertainty: How will the financial markets react if the U.S. does indeed go over the cliff?
Third uncertainty: If the U.S. does indeed go over the cliff, how quickly will Congress and the President move on a solution in January?
Fourth uncertainty: Will the financial markets be placated if it looks like a January solution is likely?
Fifth uncertainty: Is the dysfunction in Washington as great as we fear in our nightmares and could the fiscal cliff crisis morph into a debt ceiling debacle with no solution to the cliff in January?
I could go on imagining better and worse for quite a while, but let’s stop there.
Here’s how I see the odds on these five uncertainties.
First, I think there’s just about no chance of a deal before December 31. The strategy of the Republican majority in the House and House Speaker John Boehner seems to be to try to force the Democrats in the Senate to put a proposal on the table with the hope—and it’s a reasonable one—that enough conservative Democrats will compromise so that the Republicans in the House get a better deal than the one they’ve turned down from President Barack Obama plus political cover by forcing the Democrats to provide the votes to pass the compromise. I think that’s one reason why the House is, as I write this on Wednesday afternoon, not scheduled to go back into session until Friday, December 28, at the earliest. I think Democratic leadership in the Senate and the House sees this one coming and they’re unlikely to bite. So no deal by the 31st by my math. (Senate Minority Leader Mitch McConnell, who could help broker a Senate deal, is up for re-election in 2014 and is likely to keep a lower profile rather than risk a conservative challenge in a Republican primary.)
Second, the financial markets have held up surprisingly well—the S&P 500 closed down just 0.45% today, for example–under the uncertainty of the fiscal cliff. I think there’s a likelihood that markets will continue to fret but not panic if Congress and the President miss the December 31 deadline—as long as investors believe in a January bungee cord. If, however, that belief starts to fray, then the market will quickly get more worried. Do note, however, that while this is in my opinion the likely market attitude, it is by no means certain. There is a sizeable, in my estimation less than 50%, chance of a sell-off if the U.S. misses the December 31 deadline. How bad could any sell off be? Well, the 2011 drop associated with the debt-ceiling crisis amounted to 18.2% from July 21 to October 3. (And, yes, I agree that not all of that was connected to the debt-ceiling crisis.) I’d guess-timate a maximum damage of less than half that—say 7%. But that’s only my guess, I freely admit.
Third, optimists are assuming that Congress and the President will reach a quick January solution if the U.S. does indeed go over the cliff. The optimists could be right—and I think their optimism is largely responsible for stocks holding up so well in this uncertainty. That also means, however, that the pessimistic possibility—that this crisis will get rolled into a debt-ceiling crisis in January—isn’t priced in. The likely shock here is to the downside if it looks like there won’t be a relatively quick January deal.
What does all this add up to in my opinion?
It suggests raising some cash right now. That move has the advantage of giving you some downside protection to any of the uncertainties I’ve outlined above. Moving to raise cash could cost you potential gains if we do get the traditional Santa Claus rally in the sessions between Christmas and the first couple of days of the New Year but the gains in such a rally, if it occurs this year, are likely to be muted from even the 1.5% gain that the Standard & Poor’s 500 has averaged since 1950. Raising some cash also gives you the chance of being in a position to bargain hunt if we do get a market drop in January or February because of this crisis. I’d expect the financial markets to bounce back relatively quickly if the delay in negotiating an end to this crisis is limited to just a few weeks. And if that’s the extent of the delay, I think the damage to the U.S. economy will be minor and 2013 could still turn out to be a good year for U.S. stocks. If that were the case I certainly wouldn’t mind being in a position to put some money to work at lower prices.
It’s not the dimension; it’s the direction that has the financial markets worried this morning after Alcoa (AA) reported third quarter earnings of 3 cents a share—excluding non-recurring items. That was better than the consensus estimate of a flat quarter. At $5.83 billion revenue was down 9.1% from the third quarter of 2011 but above the consensus estimate of $5.57 billion.
The problem, though, is that those better than consensus numbers came with a lower company forecast on global aluminum demand for 2012. Alcoa now estimates that global demand will grow by 6% in 2012. That’s down from the company’s earlier forecast of 7% growth in demand for the year. 6% demand growth would be the lowest rate of growth since the recession of 2008-2009. Demand grew by 13% in 2010 and 10% in 2011. (The company also said that it still expects that global aluminum demand will double from 2010 to 2020.)
The reason for the lower forecast? China, of course. Slower economic growth in China means slower growth in demand for aluminum.
When does that slower growth in China stop and when does China’s growth rate start to accelerate again? Alcoa CEO Klaus Kleinfeld told analysts and investors on the company’s conference call that he was “pretty confident” that stimulus measures by the Beijing government would result in an acceleration in demand, but that it was “probably going to take until the end of the fourth quarter” before the company and the Chinese economy in general saw the results.
You can see why this earnings report might make investors uneasy. On the one hand, Alcoa has reported a pattern of steady falling growth in global aluminum demand from 13% in 2010 to 10% in 2011 to a forecast 6% in 2012.
On the other hand, all that investors have is a CEO’s confidence that China’s stimulus measures will work and that investors should be able to see the results at the end of the fourth quarter.
It doesn’t help that already today other companies have echoed Alcoa’s forecast for slower growth. For example, diesel engine maker Cummins (CMI) today lowered its full year revenue guidance for 2012 to $17 billion from a previous $18 billion. Earnings Before Interest and Taxes (EBIT) are expected to be 13.5% for the year, down from prior guidance of 14.25% to 14.5%.
Cummins actually reports earnings on October 30.
The big economic news for the week comes tomorrow when investors get the September jobs numbers. The consensus forecast among economists surveyed by Briefing.com calls for the U.S. economy to have added 120,000 jobs in September. That would be an improvement from the 96,000 jobs created in August (although that figure is likely to be revised upwards in my opinion) but it would still be a far cry from the 250,000 or so jobs the U.S. economy needs to create monthly to make a significant dent in unemployment.
Today’s preview, the weekly new claims for unemployment, suggests that the modest forecasted increase in net jobs for September is about right. This morning the Labor Department reported that initial applications for unemployment rose 4,000 to 367,000 in the week ended September 29. Economists surveyed by Bloomberg were looking to a total of 370,000 new claims for the week.