The following chart illustrates an interesting contradiction of expectations. The blue 1-year and green 5-year lines represent consumers’ inflation expectations for the time periods noted. The red 5 years forward line represents what TIPS (treasury inflation protected securities) are predicting for inflation in the coming 5 years. The red line illustrates one rough gauge of future inflation expectations via the gap between yields on plain-vanilla Treasury bonds and Treasury inflation-protected securities of the same maturity. TIPS are regularly adjusted for inflation, so this gap in yields, called the break-even inflation rate, shows how much future interest traders are willing to give up for inflation protection, which can be interpreted as the future inflation rate they expect.

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This week I am just going to share some comments from various economic and investment professionals that may give you some additional insight or different perspective regarding the current economic and market conditions. 

“We’re in the early stages of a long-term recovery in global M&A volume.  Historically, you see that the up cycles (last five to eight years), and the down cycles (typically two to three years). We have just come through more than a two-year down cycle, and it is clear to me that we have turned the corner.”

                    Roger Altman, Barron’s, February 8, 2010 

“U.S. consumers are shedding debt at the fastest rate in more than six decades, largely through a wave of defaults, in a trend that underscores the depth of their financial troubles but could also help clear the way for a stronger economic recovery.”

                    Mark Whitehouse, The Wall Street Journal, March 12, 2010 

“More U.S. stocks are paying dividends that exceed bond yields than any time in at least 15years as profits rise at the fastest pace in two decades.”

                    Bloomberg, September 7, 2010 

“Investors who seek funds in which managers are willing to invest their own money seem to significantly tilt the odds in their favor.  The correlation is absolute and significant.   Among equity funds, the correlation of better returns is stronger with manager ownership than it is with low costs.”

                   Don Phillips, MorningstarAdvisor, February18, 2010 

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In the 1980’s U.S. government changed how it calculated “core” inflation by excluding price increases in food and gasoline. Unfortunately, these items are a major part of consumers’ budgets. As such, I and others believe that inflation rate in the U.S. is higher than actually reported. Also, other central banks around the world are raising interest rates to address their specific inflation concerns. Thus, at some point in time the U.S. via the Federal Reserve will need to do the same.

Currently, there is a battle on Capitol Hill regarding raising the U.S.’s debt ceiling (i.e., how much the U.S. government can borrow). Some analysts are concerned that if policymakers continue to just make very short-term extensions or worst of all not allow an extension, then the government would be forced to shut-down. This would result in the U.S. government defaulting on its debt, which many worry would cause tremendous psychology and economic damage to world stock markets and economies.

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Before I start, I want to be clear; this is an economic and not a political commentary.  I am sharing my thoughts and concerns about what is occurring currently and the potential impact on all of us.

I consistently read articles and view videos on a myriad of financial topics.  Much of them relate to institutional and fund managers and the investment strategies they are implementing and their reasoning behind them. 

Even though we are in the midst of an economic recovery, there is a tremendous amount of uncertainty and the looming “government shutdown” only adds to it.  Businesses large and small, as well as consumers, want some certainty when planning for the future.  For example, most likely you’re not going to go out and buy a new car if you know the firm you work for is getting ready to lay off 25% of the workforce.  On the other hand, if you are in a secure position, live within your means and have set money aside, then making such a purchase may be a very prudent and well thought out strategy. 

Unfortunately, there is an 800 lb. gorilla in the room that has been growing and becoming more menacing over the decades, and it is the U.S. government’s deficits and outstanding debt.  It is true that we are a government of the people and for the people and as such, we (all of us) are eventually responsible for this debt one way or another.  Currently, we are seeing the implications of not addressing this issue in Japan, Portugal, Greece, etc.  Left unaddressed, an ever-growing deficit can lead to a country printing more and more of its money to try to overcome the problem in the short-term.  Basic economics state that anytime you create more of something, then it declines in value. 

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Current economic news

• The Labor Department said the unemployment rate fell to 8.8 percent, the lowest since March 2009, as companies added workers at the fastest two-month pace since before the recession began. Approximately 216,000 new jobs were added to the economy last month, offsetting layoffs in local governments.    
• The Dow Jones industrial average closed its best start to the year.  Also, measured against other first quarters, it had its largest point gain since 1998 and the second best on record.  The stock market has been resilient in the face of uncertainty.
• The Institute of Supply Management reported a slight slowing in manufacturing growth during March.  In addition, the Commerce Department delivered more bad, but also expected news on the construction industry.  The government said construction spending fell in February to its lowest level since 1999.

Overall the momentum for the economy and stock market has been on the upside. 

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