Stocks mauled as stagflation bites

The combination of higher prices and slowing growth has central banks in a bind and investors nervous.

By Anthony Mirhaydari Apr 9, 2012 12:26PM

There's no denying it anymore: The low-volume, no-volatility, narrow-participation uptrend of the past few months is coming to a dramatic end. The NYSE Composite has sliced below its 50-day moving average as well as its lower Bollinger Band on a scale not seen since November. Cyclical, economically sensitive stocks are leading the decline. Ancillary markets are singing the same sad song, from commodities to junk bonds.

 

This is classic new downtrend behavior.

 

Why is it happening? The Goldilocks scenario -- seemingly stronger economic data, but not so strong as to rule out additional cheap-money easing from the Federal Reserve -- is ending, to be replaced with a nightmare stagflationary future as growth slows yet inflation remains troublesomely high with gas prices hovering near 2008 and 2011 peaks. Not only will that pressure the Fed to hold its fire on another round of quantitative easing, but it's putting pressure on foreign central banks, too.

 

 

Indeed, overnight, higher-than-expected inflation numbers out of China pushed back expectations for a reserve requirement ratio or interest rate cut by the People's Bank of China.

 

But the real catalyst for Monday's sell-off was Friday's disappointing U.S. jobs report, confirming what I've been saying for months: The recent "strengthening" of the labor market was a mirage created by retiring workers and disillusioned jobseekers leaving the workforce and pulling down the unemployment rate while an extremely warm winter artificially boosted payroll gains.

 


The proof that something wasn't right could be seen in the way inflation-adjusted real incomes dropped in three of the past four months (something that hasn't happened in a nonrecessionary environment) as consumers drew down savings to pay for higher and higher fuel prices.

 

This is the bane of stagflation in action. And there are no easy solutions, since it's combined with an ongoing balance sheet recession caused by $8 trillion in excess debt in the West, according to Credit Suisse estimates. More money printing, which the cheap-money addicts on Wall Street are clamoring for, certainly isn't the answer. 

 

 

When the Fed launched QE1 and QE2, Brent crude was trading around $40 and $75 a barrel, not the $120+ it costs now. Consumer price inflation was running at annual rate of around zero and 1%, respectively, not the nearly 3% it's running at now. And the big banks were holding $1 trillion or less in excess reserves, not the $1.5 trillion they hold now.

 

They'll do it anyway. Fed chief Bernanke won't want to take action too close to Election Day, for fear of being cast an explicit supporter of President Barack Obama's re-election team by any means necessary, including violent debasement of the dollar's value.

 

That sets the stage for a monthlong downtrend into the Fed's policy announcement on June 20, when it's likely to announce or tease QE3, which is widely expected to focus on the housing market via targeted purchases of mortgage securities. Bernanke hopes slowdown fears will take crude oil off bubble and create enough of a pullback in inflation to justify additional easing.

 

But with so much inflation already primed in the system, and monetary policy quickly losing its effectiveness, aside from igniting a massive relief rally in the financial markets, it's unlikely to restart the heart of the economy. That's because the heart remains consumer spending. And unless wages increase via new high-quality jobs, higher food and fuel prices will just continue to erode real incomes and savings until consumers are tapped out.

 

For now, I continue to recommend conservative investors move to cash to protect wealth against this nascent downtrend. For more aggressive traders, there are a plethora of opportunities for profits on the short side. Over the past few weeks, energy, industrial metals and emerging-market stocks have been the place to be. The Edge Letter Sample Portfolio has been holding positions in these areas.

 

Examples include shorts in National Bank of Greece (NBG), up 32% since February, and PennWest Energy (PWE), up 12.2% since March 28. Short ETF holdings include Direxion 3x Daily Energy Bear (ERY), up 14.4% since March 22.

 

The next stage of the pullback seems to be focusing on semiconductor stocks. Recent additions in this area include a short in Vishay Intertech (VSH) and the Direxion 3x Daily Semiconductor Bear (SOXS).

 

I'm adding two new shorts to the Edge Letter Sample Portfolio: Cemex S.A. (CX), a cement maker being pummeled along with the rest of the materials sector, and Brocade Communications Systems (BRCD), a networking equipment provider.

 

I found CX and BRCD with the help of technical screens developed with Fidelity's Wealth Lab Pro back-testing tools, which you can find here. (Fidelity sponsors the Investor Pro section on MSN Money.)

 


Check out Anthony's investment advisory service The Edge. A two-week free trial has been extended to MSN Money readers. Click here to sign up. Contact Anthony at anthony@edgeletter.c​om and follow him on Twitter at @EdgeLetter. You can view his current stock picks here. Feel free to comment below.

 

 

33Comments
Apr 9, 2012 2:10PM
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Hayek wrote years ago that the reason central planning does not work is not because the planners are not well intentioned; but because the market and individuals are complex.  You can never plan for every change in the economy and we are in that mess right now.  We put in almost 1 trillion in stimulus, bailed out banks, car companies and have tried twice now to fix the housing market.  Two rounds of quantitative easing and all it did was provide a temporary boost and allow us to lag along. 

 

Get the government out of the way, and let's try for once to let the markets work and recover.  This will never happen because the folks in Washington view themselves as the smartest men in the room and view us as just sheeples. 

 

Wake up America! 

Apr 9, 2012 2:37PM
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I don't see any reporting of the 20%, or more, price increse on grocery items. Not counting the decrease in product weight and size.

The average guy, will never keep up.

Time to get someone to give us the true figures.

Apr 9, 2012 2:12PM
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"And unless wages increase via new high-quality jobs, higher food and fuel prices will just continue to erode real incomes and savings until consumers are tapped out."


and then what after they are tapped out?

Apr 9, 2012 1:57PM
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"And unless wages increase via new high-quality jobs, higher food and fuel prices will just continue to erode real incomes and savings until consumers are tapped out."

 

Forget the charts, figures, graphs, stock market trends, bernanke and everything else.  This statement in the article is the bottom line result.  ipso-facto

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The other day an ad came on TV telling the American people to "watch" for Medicare fraud and to "report it to the authorities".   This is not the job of the American people to go out and search for fraud in the Medicare system.  It is the job of the police and Gov't agencies like the FBI. 

 

What do you have initiated next Mr. President in this time of Stagflation and distrust, the Stasi or NKVD groups to go around and "make sure" your wishes are carried out?   Were some of them in Wisconsin last year at the capital building?    Or will we find out our children have been told by their teachers to watch their own parents and report any suspicious activities to the police?

 

We have seen you push through your agenda, we have seen you berate duly elected or nominated Federal justices that do not find in your favor.

 

These are dangerous times we live in and economic Stagnation can bring out the beast in the best of people.    America should be very wary of our elected people during these times. 

Apr 9, 2012 2:38PM
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This policy of "financial repression" by the Fed has brought this country to the edge of the " fiscal cliff. "  In other words,  the Fed kept interest rates artificially low to have cheap money but the money people kept on spending money like it was going out of style on government programs domestic and overseas.  Correct me if I am wrong, but the US has been down this road and it was not pretty.  Smile
Apr 9, 2012 5:20PM
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I do not see any real improvement in the economy or jobs.  A few days of upticks has now become a "market rally".  Look at a graph for the last 30 years.  Is it possible that the market is at over-inflated levels, and has been for some time?  Is it possible that the market is trying to find balance and real value, but too many people have a vested interest in atificially high numbers?  Doesn't anyone realize it is long past time to quit blowing smoke and wake up to the real problems we are facing?  Politicians, big business, greedy corporations, and ME FIRST! need to look at the real world, read a little history, get a better grip on reality.  We are on the edge of the precipice, and the edge is crumbling.
Apr 9, 2012 3:14PM
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I thnk a relatively small cadre of high frequency trading houses can manipulate the markets, particularly during a prolonged relatively low volume cycle.   I also think the Fed has been a major influence to inflate the market through index futures purchases, particularly timed to mitigate market drops and again distorted by low volume overall.  To say nothing of QE ad nauseum, where eventual inflation and currency debasement seem their only options. let's not even get into real inflation or real unemployment numbers compared to the nonsense they put out. What consumers are left with is diminished buying power and a growing sense of unease that papering over the problem is not solving it.  
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well it's time for a diet of rice and beans and hope they do not get as high as beef prices.


Apr 9, 2012 3:51PM
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The people on this board are a little tough on shooting the messanger. He's merely attempting to explain something in the market that may have consequences for investors. He cannot tell the future, nor is he trying to predict the future. However, he is saying that if a trend that he sees is correct and continues, there are consequences. That's it.
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paul neville:

The biggest problem with the price of oil is:

 

It is tied to the price of the American Dollar.  

 

The next biggest problem is:

 

 the President's economic policies.  

 

When the dollar was strong, oil prices were about US $40 a barrel.   As the dollar was deflated with the Fed printing unlimited amount of money, the value of the dollar decreased about to 1/3 what it was in the recent past.   Now the price of oil is reaching over US $100/barrel and wanting to go to US $120/barrel.   With further QE easing, the value of the dollar will go down to about 1/8 of the value it was when oil was US $40/barrel.    Yes, it has been said that there will be no further easing, but like the weather in Wisconsin, if you don't like it today, hang around for a few days.

 

Now when oil prices get that high, our President will say it is time to change over to "Green Energy" by using a Federal Gov't emergency mandate, even though there isn't enough solar or wind energy production to go around no matter if we load the whole country from Ocean to Ocean, from Gulf to the Canadian Border with Solar and wind turbines.  

Green (carbonless) fuel is a big wish on the part of those forcing us to pay these high prices at the pumps.   If wishes were wings we would all be able to fly.

Our President said he would do this and he has done it.   One of the few campaign promises he has kept with the help of the Fed's printing press.  Too bad he would rather destroy the country financially than let us use Natural Gas as a bridge fuel until we can find the future clean energy his followers so desires.

 

We have a narcissistic person in the White House that feeds his desires with the blood of the American consumer and wage earner.   He is the virtual Vampire that is attempting to keep his flock to the absolute maximum by keeping them on Welfare or unemployment and forcing those that oppose him to pay their "fair share" of their own blood so that his flock can willingly stay available to him in his most pressing time of need..   The sun is starting to set.  Watch out for November's darkness.

Apr 9, 2012 4:47PM
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This is just the latest in the long crisis started in 2007.  It is not going to end.  The growth mantra is over.   The elderly and those who can are taking their chips off the table and moving to the countryside.
Everyone must soon decide what kind of culture you want to live in.  ---- Even if it requires action by the states to regionalize with separate immigration policies.



Apr 9, 2012 5:11PM
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If you think Anthony has it all wrong then listen to Cramer. Cramer said just a few weeks ago the rally has legs. Bet on Cramer if that's what you want to hear. No one seems to talk about the baby boomers. They have controlled the economy for the last 65 years. And counting. What are they doing now? Retiring. 10,000 a day. Every day. For the next 18 years. They are pulling cash out of Wall Street instead of putting it in like they did beginning in 1980, which was the biggest reason for the huge bull market that ended in 2000. Lets see the Fed fix that.
Apr 9, 2012 6:29PM
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The fed has been printing dollars faster than drunk counterfeiting monkeys. They've decided not to call it QE this time around just print and keep their mouths shut. The inflation has been finding its way into the economy and they've been able to hide it by using adjusted CPI and PPI numbers. This causes and the deflator number to be misstated and it leads to numbers that look like a real recovery instead of the phony recovery it is. This is causing a cluster of errors among businesses right now. These mal-investments will further hamper any progress toward a real recovery.

 

Little has changed regarding the velocity of money so far other than the higher prices of food and gasoline. As more of the feds monopoly money enters the economy (and it will) the velocity of money will increase.  That increase will cause more, not less of the money to spill out into the economy and unless there is drastic action inflation could run away from the planners in a hurry.

 

Whether or not the fed will act in time is debatable. While Ben Bernanke has assured congress that he could act in an instant it is doubtful that he can. It should be considered also that the higher interest rates that would be required to quell an inflationary spiral will cause the federal debt to soar quickly since the majority of government paper is short term.

 

Good luck out there 

Apr 9, 2012 3:51PM
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I don't know about the critics, but i've been following Anthony's advice for more than a year and have found it invaluable. There was a rough patch in January and February, something he has admitted to.

He turned bullish in late September/ early October ahead of the massive October rebound.
He was negative into the November and December pullbacks.
And he had a number of very good calls on precious metals in January and February.

One last thing: Has anyone even looked at his picks lately? Or how the job market is weakening, as he has been saying for months?

Good grief.

Apr 9, 2012 3:59PM
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Misteriman2

I think it destroys YOUR credibility that you keep repeating the same drivel when it's obviously not true. He has made plenty of good picks along the way as he waits for the big pullback. Much of the market (small caps, energy, materials) has been flat/down for months.

And what of your constant comments about the job market being great, criticizing Anthony's analysis of wage weakness, etc etc over the last two months? Friday's numbers must've hurt, eh?
Apr 9, 2012 3:04PM
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Disabled vet - first thank you for your service to your country.  Remember that about .80 -1.50 of that price we pay at the pump for gas is government taxes, dependent on which state you live in.   
Apr 9, 2012 4:10PM
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Pull out your platform shoes and royal blue Swedish-knit leisure suit, because its gonna get retro REAL FAST in here!
Apr 9, 2012 4:38PM
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JAY60 ,Thank you for your kind words and youre correct in the taxes paid per gallon of gas, but in the very recent times

I saw that the crude dropped $4-5.50 and the gas went up before opening the next morning. I admit I am not as learned as

most of you about this matter, on this board but that really doesn't make a lot of common sense, does It?

Once again thank you for your kind words on behalf of many , many ,many VETS.

Apr 9, 2012 10:19PM
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130 point drop .. "mauled" ??  given the recent increases wouldn't this be a MINOR move?
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