World Markets 101

U.S. Taxpayers to Subsidize Lattes?

Yes, you read that right, congressional democrats are introducing a bill that would halt the planned closure of some 600 unprofitable Starbucks stores.  Representative Pelosi’s bill would subsidize the money losing stores using millions of U.S. taxpayer dollars.

Repesentative Pelosi states that the 12,000 baristas at risk of losing their jobs “can’t just walk out of Starbucks and get a job at a grocery store or a factory.”  Mentioning that many of them cannot speak English and would need “ESL classes and cultural training to learn how to relate to ordinary Americans and function in society.” She goes on to say “America has become a cold and desolate place where corporations cut unprofitable activities to focus on increasing the bottom line, and returning value to shareholders. When Democrats retake the White House next year, we will reverse that trend.” Thanks Nancy, I’ll look forward to having my 401k gains reversed too.

Protecting Yourself from Inflation

Anyone who has traveled to Europe lately knows that the value of the dollar is far from what it used to be.   The dollar has declined 28% versus the Euro over the past five years.  Rather than simply complaining about the value of the dollar or the jump in food or gas prices, you need to develop a strategy to protect your assets from inflation.  I recommend buying the book “The Coming Generational Storm”.  Written in 2004, the book has been deadly accurate in its predictions.  The book describes the future of America and describes strategies to protect your wealth during large macro economic trends that are occurring or will occur in the near future.  Below are some instruments that are available to the individual investor that will help protect the value of your assets from inflation:

Treasury Inflation Protected Securities – TIPs pay interest semi-annually while the principal is adjusted for the consumer price index.  The semi-annual interest is paid on the adjusted principal.  When the bond matures, you are paid the adjusted principal or the original principal whichever is greater.  For example, suppose an individual invests $1,000 on January 15 in a new inflation-protected 10- year note with a 3% real rate of return.

• If inflation was 1% during the first six months of that year, then by mid-year the inflation-adjusted principal amount of the security would be $1,010.
• In addition, at mid-year, on July 15, the investor would receive the first semiannual interest payment of $15.15 ($1,010 times 3% divided by 2).
• Suppose, then, that inflation accelerated during the second half of the year, so that it reached 3% for the full year.
• By the second semiannual interest payment date, January 15, the inflation-adjusted principal amount of the security would be $1,030.
• The second semiannual interest payment would be $15.45 ($1,030 times 3% divided by 2).

Gold – Gold is the default currency when people decide that the country’s currency is not worth the paper it’s printed on.  Gold is quoted in dollar terms, and typically as the dollar declines against the major currencies the value of gold increases.  However, keep in mind that 65% of gold demand is driven by jewelry purchases, so a sharp move up in gold may cause a decrease in demand in the short run.   

International Bond Funds – International bond funds invest in bonds from other countries and pay interest in currencies other than the dollar.  An international bond fund must be unhedged to protect against a decline in the dollar.  Also make sure that the fund is a no load fund with low expenses otherwise the costs will erode your return.

International Certificates of Deposit – Services like Everbank.com offer certificates of deposit from around the globe that are similar to CD’s in the U.S.  You may be surprised to learn that these investments also come FDIC insured up to $100,000.  For instance, an investment in a one year CD in Brazil will earn a 6% return.  If the dollar depreciates by 3% against the Brazilian real during the investment’s life the result will be a 9% return.

Energy Trusts and Commodity ETFs – An investor can purchase shares in energy trusts that pay a dividends based on the price of a barrel of oil multiplied by the number of barrels sold from the trust.  There are also ETFs that allow investors to buy oil or grains directly. 

As you can see, there are plenty of ways to protect your wealth from inflation.  Be sure to contact an advisor before investing in any of these instruments to ensure that the investment is suitable for you and your portfolio. 

Lies, Damn Lies and CPI

Every month the Bureau of Labor Statistics (BLS) tracks the prices of more than 80,000 goods and services and distills them into one number, the Consumer Price Index (CPI), but upon release, a lot of people don’t believe it.  The CPI continues to be a testament to the art of economic spin.  Since wages, social security cost of living increases and some agency increases are tied to CPI the government has a vested interest in keeping it as low as possible.

Composition of the market basket: The prices of the various goods and services that make up the CPI are weighted according to a standard market basket that represents the way people spend based on the Consumer Expenditure Survey. The category weightings are as follows:

Food and beverages	15%
Housing	43%
Apparel	4%
Transportation	17%
Medical care	6%
Recreation	6%
Education and communication	6%
Other goods and services	3%

If spending patterns diverge from these weightings, individuals may perceive inflation to be higher or lower than the reported CPI. For example, if a family spent more than the standard allocation of 6% on medical care, their own personal inflation rate could be higher than the stated CPI.

One component of the market basket – housing – warrants additional scrutiny.  The “shelter” component of housing represents 32% of the total CPI index.  CPI calculations use implied rent figures when computing housing costs, rather than the cost of home ownership.  Until recently, home prices rose dramatically while rent costs lagged, leading some economists to believe that the CPI was understating the true rate of inflation.  With the recent decline in housing prices and home equity, homeowners who can no longer afford their homes may be forced to rent, forcing rental rates higher, and possibly having a dramatic effect on the CPI.

In many respects, the cost of energy –specifically oil- attracts the most attention for consumers.  With oil prices at all-time inflation-adjusted highs, many consumers are fearful of the effect this will have on their budgets.  But automobile gasoline represents just 4.4% of the CPI, while public transportation represents 1.1%, and household fuel oil is a mere .2%.  So the direct effect of increases in oil prices will not substantially impact the CPI. 

The composition of the CPI market basket is adjusted infrequently, sometimes at intervals as long as ten years. In 1998 several changes were made to the way the CPI is calculated. One of these changes relates to the way people shop.  Instead of buying the same item every week, they might be alert to temporary price hikes and substitute a cheaper item when possible. If their favorite brand of ice cream is more expensive than usual, for example, they might switch brands, buy it at a different store, buy a smaller size, or settle for a different dessert. This substitution adjustment has the effect of lowering the CPI, compared to using prices for the same items every week. 

It is easy to see that the CPI calculation is far from perfect.  Aside from the shortfalls I’ve described above, it also does not capture increases in taxes and fees.  So as items like property tax, title fees and sales tax increase, the CPI will stay the same. 

The Leading Indicators of a Recession

There are several key recession indicators that tend to turn down just as a recession begins:

·         Auto and truck sales

·         Building permits

·         Initial claims

·         The jobs report

Auto and Truck Sales

The importance of auto and truck sales lies in the fact that it tracks the very first economic indicator, along with building permits, to turn down when the economy begins to slide into a recession.  This is because when consumers begin to worry about the economic outlook, one of the first things they tend to do is postpone or cancel decisions to buy big-ticket items like autos or homes.                          

Building Permits

The building permits number can be very volatile due to weather changes and natural disasters.  Together with auto and truck sales housing is the first to turn down as the economy enters a recession.  Almost all of the economic turnarounds over the past 50 years have been precipitated by changes in these sectors.  Conversely, it is worth noting that the housing sector is the first to turn around when an economy is coming out of a recession. 

Initial Claims

The initial claims report is a weekly report that can be very volatile.  It contains the latest data on new claims for unemployment benefits.  This report is important because people going on the unemployment line represent a very early warning that all is not well in production land. 

The Jobs Report

This is the most important report of all leading indicators.  The jobs report contains key data on the nation’s unemployment rate, nonfarm payrolls, average hours worked and average hourly earnings.  The jobs report helps set the tone for the market for the month and therefore the market trend as well.  The unemployment rate in the report can be political dynamite.  A sharp rise in this rate is likely to lead to a very swift fiscal or monetary policy response- especially in an election year.

Illegal Labor; the Lowdown on the Potential Crackdown (October 2007)

As the government plans to crackdown on illegal labor many businesses are scrambling to figure out how they would cope with the potential loss.  Many business owners particularly in agriculture, construction, and food service rely heavily on illegal workers.  Most small businesses that employ illegal workers state that their survival depends on the workers continued employment.

The cooking, construction, housekeeping, landscaping and agriculture industry employed the majority of the 7.3 million illegal workers in the U.S. in 2005. In the $1.2 trillion dollar construction industry, at least one-third of the workforce is undocumented, according to an estimate by the bureau of labor and statistics.  Some experts believe this number could be even higher; last year alone, nearly half of new construction workers were Hispanics who had arrived in the U.S. since 2000. 

In agriculture, about 70% of all workers are illegal immigrants, according to independent estimates, and an existing guest worker program supplies less than 2% of the work force required each year.  Most of these illegal workers work for legitimate businesses and are paid through the normal payroll functions.  To get hired, immigrants typically obtain a fake social security card with a made up number.

Employers have a difficult time indentifying false documents and as a result immigrants are hired and the necessary taxes are withheld.  The workers pay into Social Security, yet they are unable to draw benefits in the future.  The recent push is seeking to require employers who receive no match letters from the Social Security Administration to certify the workers legal status within 90 days otherwise they must be terminated immediately.

The alternative to moving operations across the border or simply closing shop would be to hire legal workers and raise prices.  Americans have benefited from cheap labor both in the U.S. and abroad, but decreasing the size of the workforce could put pressure on wage inflation.  If the crackdown is successful, count on seeing more items you purchase increase in price.