October has brought many economic and social issues to attention, including evidence of inflation in a seemingly strong US economy, Bush’s selection of Ben Bernanke to succeed Alan Greenspan as Federal Reserve Chairman, as well as a fresh list of international distractions to take the public’s mind off of local issues.

INFLATION & STRONG ECONOMY
Although no one wants inflation, investors want to see it because once recognized, one can estimate the extent of its effects and take appropriate strategic action. With this in mind, some are concerned that inflation may be coming, some believe that inflation has just arrived, and some recognize it as having started earlier this year. Thus, the market is guessing at the scope of trouble.

  • A two year increase in energy prices that is expected to shock consumer and corporate wallets this winter (home heating bills up 50% year over year)
  • Consumer Price Index’s (CPI) one-year rate hit a 14-year high of 4.7% in September
  • A five year run-up in real-estate prices (that never showed up in CPI)
  • Fears of US government and populist retribution against excessive imports
  • Sentiment that the end of Greenspan’s career as Fed Chairman will coincide with the end of Federal Funds rate hikes
  • US construction spending has increased in each of the last three months to a record annualized amount, $1.1 trillion (creating inflationary pressure on building inputs)
  • Rebuilding the Gulf Coast will further boost construction spending and inflationary pressure

Thus, even with the Fed’s consistent (inflation fighting) rate increases and another expected in December, the above series of cumulative events are convincing the markets that inflation, either here or coming, is a force to reckon with.

Notwithstanding inflation – and the belief that most Americans perilously under save and overspend – the US economy seems to be in good shape. In addition, the dollar has strengthened well against European currencies as the US Fed has continued to raise interest rates in the face of the European Central Bank (ECB) keeping rates flat. However, this strength may be moderated because the ECB is considering raising rates as German, French and Italian manufacturing activity increases. In addition, with a record 13.6% of disposable income spent on debt service, there is less money available to chase real goods and fuel inflation.

Therefore, in the wake of President George Bush’s announcement that Ben Bernanke will replace Alan Greenspan as the next Federal Reserve Chairman, pundits – who mostly all see Bernanke as a positive selection – are hypothesizing on what battles he will face next year: inflation, deflation, strong dollar, etc.

INTERNATIONAL DISRUPTIONS
Simultaneous with the announcement of Bernanke, American media is guiding our attention away from local issues:

  • Earthquakes in Kashmir
  • Insurrection in France by disillusioned suburban youths (many of them French-born children of immigrants) that are roiling Prime Minister Dominique de Villepin
  • Anti-US demonstrations in Argentina
  • International fear of a pandemic bird flu

Despite questions regarding US economic strains, on a macro scale, international investors will probably continue to view the US as an attractive safe haven for their assets.

 

Greg P. Pellizzon
Managing Director

Michael Ashley Schulman, CFA
Director

Hollencrest Capital Management
www.hollencrest.com