of Retail Prices (2003-Present)
economy sends stocks soaring. Have you ever head of an investing
headline that was more counter intuitive than that?
Investing 101, states that when we invest we are in fact purchasing
a series of future cash flows. If the actual value of those
future cash flows turns out to be more than the current estimate
of the present value of those cash flows then we are likely
to earn a profit on that investment.
Businesses activity takes place within the framework of the
economy within which they operate so if the economy is slowing
then that should be a cause for concern for investors as it
may make for a more challenging business environment in the
future which may then impact on the ability to generate the
expected levels of cash flows over time.
Yet the headline that the slowing economy was the reason behind
the rising stock market in the US over the last week was splashed
across many newswires on Friday last.
This assumption was based on the performance of the markets
last week, especially on Friday itself when the Dow gained
119.27 points or 1.07 per cent to close at 11, 219.70.
For the week the Dow ended up posting its best weekly point
gain since May 2005. Overall the index ended up 351.32 or
3.23 per cent while the S&P 500 posted weekly gains of
3.08 per cent and the Nasdaq 3.65 per cent.
Comments from the US Federal Reserve Chairman that the economy
was moderating put investors in a positive mood at the start
of the week as these comments implied that the Fed would probably
be nearing the end of the cycle of 17, 25-basis point rate
Last Friday the US Commerce Department confirmed the slow
down releasing data to show that GDP for the second quarter
April to June increased by an annualised rate of just 2.5
This was a big slow down from the first quarter which posted
a 5.6 per cent growth ratethe fastest in two years.
In the final quarter of 2005, GDP growth was 1.8 per cent
as a result of the fallout from the Gulf Coast hurricanes.
The US economy compensated in Q1 of 2006 as reconstruction
work commenced but the Q2 performance was below the three
per cent growth rate that analysts were forecasting.
Did someone say recession?
When you put it all together investors should be concerned
especially when you also factor in that core consumer prices
(excluding energy and food) rose to 2.9 per cent while employment
costs also increased a stronger than expected 0.9 per cent.
The latter two indicators suggest that inflation is still
a factor in the US economy and neither inflation nor slower
economic growth is good for stocks over the long term.
The core inflation reading of 2.9 per cent was up from 2.1
per cent in Q1 and marked the highest inflation rate since
Q3 of 1994. Yet despite this the fact that the market still
rallied may also offer some level of circumstantial evidence
as to the degree of short term trading that currently exists.
The US economy is slowing and inflation is rising. Investors
who rallied the market this week are essentially betting that
the slowing economy will itself bring inflation in check.
Yet there seems to be more to the equation and there are real
risks that something more troubling (even a recession) is
beginning to emerge. Data now suggests that there is a slow
down in consumer spending as higher gasoline prices begins
to take its toll. Less money is being spent on durable goods,
homes and automobiles and more money on necessities. At present
consumer spending accounts for around 70 per cent of US GDP.
With energy prices doubling over the past couple of years
at some time a slow down in consumer spending was expected.
Many analysts were hoping that this slow down would have been
offset by a rise in business spending.
Right now the evidence does not support this as Q2 has seen
businesses reduce spending on equipment and softwarethe
first such decline in three years.
The macro economic picture is causing concern but this is
not yet being reflected in the corporate outlook.
With more than half of the companies that comprise the S&P
already releasing results, Thomson Financial is reporting
that earnings growth for the index is expected to be up 14.8
per cent for the quarter and double digit growth could last
to the end of 2006.
US stocks were not the only security to rally last week. The
US Treasury market also rallied resulting in a drop in yields.
Yields on the ten year note fell below five per cent to close
the week on 4.99 per cent. Yields on the two year note also
fell and an inverted yield curve remained in effect.
If the Fed were to continue with another rate hike under the
same status quo then the yield curve would show a sharper
inversion increasing the statistical probability of a recession
down the road.
The outlook for the US economy is now balanced on a knife
edge and one false move can even see a return to the stagflation
phenomenon of the 1970s where growth was stagnant but inflation
Problems of our own
Speaking of a delicate balance those were the exact words
the IMF used a couple of weeks ago to describe the way the
local economy should be managed.
This balance involves investing energy windfalls efficiently
to advance long-term economic and social objectives, while
pacing the use of energy revenues to avoid overheating the
economy and pushing up inflation.
The IMF further went on to state that the economy is showing
signs that it is now operating near capacity. Inflation
has accelerated, real estate prices are rising, capacity constraints
have become evident in some sectors, and the labour market
To many the situation described by the IMF is not new. I recall
writing on the threat of inflation since mid-2004.
Yet the situation is still being allowed to continue unabated
and every time there is more data emanating from the Central
Bank it becomes clear that rather than getting better it is
in fact getting worse.
Last Fridays repo announcement by the Central Bank stated
that the latest data released by the Central Statistical
Office indicate that the domestic economy continues to experience
inflationary pressures. On a year-on-year basis to June, headline
inflation increased by 8.65 per cent from 7.97 per cent in
the previous month. Food prices, which continue to drive headline
inflation, rose by 3.7 per cent in June and on a year-on-year
basis by 25.7 per cent. Contributing to the sharp rise in
food prices were increases in the prices of vegetables (67.9
per cent), fruit (33.5 per cent), fish (31.9 per cent) and
meat (10.2 per cent).
This sounds very much like a broken record as every announcement
carries the same news of rising prices.
Over the period October 2004 to October 2005 food prices rose
at a rate of 22 per cent year-on-year. The current year on
year increase is 25.7 per cent.
In November 2005 I wrote: Over the period 2000 to 2004
food prices increased by an average of 11.8 per cent, however
the above average increases in food prices started in 2003
as from October 2003 to September 2004 food prices increased
by 13.3 per cent.
22 per cent year-on-year increase for 2005 represents a doubling
of the average increase over the four previous years. The
problem of rising food prices have therefore been with us
for quite a while especially in the last two years and is
having a critical negative impact on the economy.
the Ministries of Agriculture and Finance have to redouble
their efforts to deal with this problem since what has been
done so far has not been adequate. In my view there is a limit
as to what the Central Bank can do to deal with this type
of inflationary pressure since food is not a luxury item.
Further as I indicated last week, the tax break from the recent
budget could easily be negated by rising food prices during
the coming months.
Eight months later and we are no closer to dealing with the
problem of higher food pricesa problem that has been
brewing for a number of years.
The problem of rising food prices is not the making of the
Central Bank nor are they in a position to fix it. Increasing
interest rates and absorbing liquidity from the economy only
serves to slow the rate of economic growth.
The analysis of the US markets at the start of this piece
should make that clear. The fact that these measures will
only impact the non-energy and the private sectors means that
these areas will slow down disproportionately leading to stagflation
in the non-energy sector and therefore further dependence
on the State for resources.
Further if we analyse the food items that are increasing (vegetables,
fruit, fish and meat) there is a heavy local component to
Blaming supermarket owners, calling for the removal of VAT
or any other such measure does not address the root cause
of the problem and clearly there needs to be some accountability
as to how and why we have allowed this situation to deteriorate
to the point where it is now.
It may sound controversial but the impact of unused Caroni
lands and the lack of agricultural impetus over the past couple
of years could certainly be causal factors in the problems
we are facing today.
If it is, then it will certainly drive home the point that
everyone who lives here is affected by decisions that are
made here. Not all of us were associated with Caroni 1975
Ltd but all of us have to eat.
The first part of this article spoke of the perils facing
the US economy. If their worst case scenario of a recession
were to come true would that not also imply a falling demand
for energy resulting in a weakening of oil and gas prices?
Would we be able to adequately feed ourselves in the absence
of a continuing oil and gas windfall?
Lest I be accused of being political let me conclude by pointing
out that information from the United Nations Conference on
Trade and Development shows that as far back as 1990, agricultural
production was barely one seventh of the norm for a country
of our size and level of developmentthis problem has
been with us for a long time.
Just a few days ago we were reminded of what happened in 1990.
The high cost of food and other basic necessities was one
of the factors which contributed to the actions taken then.
In this week of Emancipation can we not do what is needed
as a country to emancipate ourselves to the point where we
are self sufficient in food production?
Ian Narine, managing director of Republic Securities Ltd can
be contacted via e-mail at [email protected]