Third Time is Not a Charm

As everyone has heard, the Dow is nearly setting new highs. Essentially, it has topped the previous closing high, briefly. It has failed at nearly that level three days in a row, closing down on Friday nearly 40 points. Quietly, the market is showing a measured reaction to Friday's consumption and spending reports. The CPE core deflator is derived by comparing these figures. Some say the Fed focuses on this index more than the to the tradional CPI and PPI data.

The Fed doesn't really like to tell people how they make their decisions other than to say they look at broad measures of the economy. And let's face it, if anyone knows how Greespan sorted all that out, they have yet to go public.

Getting to the CPE data released on Friday, I noticed that the year-on-year number is up to 2.5% which is up from the 2.1 and 2.2 levels it has been bouncing around in over the last four months. I don't know how significant this is, but it may mean that the high headline numbers we have been seeing are starting to filter down into the core numbers.

I just read a piece that suggests that core numbers are a fallacy because they remove "volatile" food and energy costs. He makes some good points, but I like the core number because it shows a later stage of inflation: where the knock-on effects of higher energy prices start filtering into the larger economy, or the whole economy as it were.

The ISM index comes out on Monday. This is the broadest measure of industrial output available. There was a scare earlier in the month because of a surprisingly low headline number out of the Philly Fed. Yesterday's Chigago's Fed alleviated some of those fears, but I'll wait until the ISM data hits tomorrow, and I won't be alone.

A particularly bad ISM number could trigger a sharp drop in equities, but this unlikely to happen. I trust the Chicago number much more than the Philly's. The Chicago index has a 91% correspondance rate with the ISM. (These two smaller district indexes are considered the most important early indicators for the broader ISM index).

But risk exists. The market is probably over extended, and it shows signs of fatigue failing to set the new closing high three days in a row.

Now, getting to the big question... why isn't the market paying attention to the housing sector? The more I look at this, it is clear that it is a time bomb if inflation kicks in. Despite all the warnings, apparently negative-amortization loans went on unchecked. Really, read the aritcle, it is a good one from an unbiased source. I didn't realize that California has been issuing nearly 30% negative-amortization loans in 2006. In that market? That is insane!

So the fear is that the Fed will be stuck in a tight spot where they will be facing high inflation numbers (which hasn't happend yet) and pressure from the banking sector not to raise rates (in full swing).

If inflation forces the Fed's hands, they will be in a position of creating a banking crisis as raising interest rates will force so many loans into foreclosure that the banks would have a problem with solvency.

So for now, everyone is hiding their heads under their pillows and hoping for the best, because it is clear that even a 6% rate would have disasterous effect. We should be hoping for an economic slowdown, because if the corporate secortor keeps barging ahead at break-neck speed, it is our necks that get broken when the crash comes.

I'll leave my reader with a couple of quotes from European analysts/fund managers who I find more sensible than their American counterparts... (sorry, no names I just heard them in the backgroud in passing and they cought my ear).

"We are seeing texbook preliminary signs of an economic slowdown. It has begun in the housing sector and it will move it's way through the normal path with the corportate sector being the last to feel the effects."

"We have been riding a tiger, and when you ride a tiger, you have to know when to get off."

It might be just about that time.

(h/t Reality-based Educator for the motivation)