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Wilkinson's Edge: Gin and Gingerbread

Friday, 16 December 2005 12:00 AM



Dear MoneyNews Reader,

The NewsMax office had the distinct feel of the holiday season in the air this week. And with good reason too. Early in the day I stopped by a local Starbucks and treated myself to a gingerbread latte.

No sooner was it in my hand than I caught the bottom of the cup on the wheel and proceeded to spill a good portion of the liquid onto my car seat.

That was a great start to the day as I felt the coffee creep slowly into the seat of my pants.

By the time I got to my desk, the feeling was uncomfortable and I reeked of gingerbread coffee.

All day long, people approached my cubicle as if strangely attracted by the indefinable odor of that curious winter aroma.

By lunchtime I'd had enough of explaining myself and just kept quiet. Instead I focused on finishing the day's work ahead of the annual office party.

But things didn't go much better, as I got to the party late - thanks to taking a wrong turn on the highway.

I arrived at the buffet and lined up at the bar for a customary London gin and tonic. Then, as I turned back to join the crowd, a fumbling waiter stumbled right into me, sending my cocktail all over my jacket.

Before the buffet was even open I carried the curious combination of gin and gingerbread.

Hard to explain but true.

Shares in our favorite satellite radio play generated a fresh buy signal this past Thursday, according to my

I sent out an urgent trading alert to my

Sign up for a risk-free trial to my

I recall a comical observation I heard several years ago from a European Central Bank official.

He drew upon an analogy to explain the importance of nipping inflation in the bud before it spirals out of control.

He actually said that allowing a bit of inflation to creep into the system was similar to the feeling of peeing one's pants.

At first it is warm and comfortable and provides incredible and immediate relief.

But before long, just as my experience with the gingerbread latte proved, the warm sensation is replaced by discomfort.

This week the Fed signaled that it might be close to a peak in rates, as is has done what is necessary to keep its own pants well and truly dry.

In the wake of Tuesday's Fed decision to raise interest rates for the thirteenth consecutive time, the immediate reaction was to buy stocks.

And that surprised me somewhat, but at least the message was a little clearer right out of the gate. The Fed is closer to having finished raising rates than it previously was.

The big winner shouldn't necessarily have been equities - but bonds instead.

The Fed's accompanying statement was notably shorter than previous efforts. In it, the Fed focused investors' minds on growth, despite high energy costs and the impact of the hurricane season this year. The statement referred to the current and future growth prospects as "solid."

For the year to date, American equities have performed poorly, compared to global markets. While other central banks are reluctant to interfere with monetary policy, the clear message since June 2004 is that rates are heading higher in the U.S.

It is difficult to determine whether that has clouded investors' vision about future growth.

It's easy to blame a rising interest-rate environment for the lack of capital gains on equities - but Americans are more optimistic than that.

When you consider that the Japanese Nikkei Dow index has risen by one-third in 2005, you realize that the marginally positive return of less than 5% on America's S&P 500 index is pretty sad.

The bigger news in Tuesday's announcement was the removal of the term "accommodative" from the Fed's statement.

In each of the explanatory statements in this cycle, the Fed has pointed out that monetary policy remained accommodative, implying that even with each rate increase, the conditions surrounding monetary policy were still adding to growth.

In other words, rates were still so low that consumers were not likely to feel the bite - nor would corporations shrink from borrowing more debt at low bond yields.

When you consider that bond yields behaved irrationally throughout this cycle (by falling rather than rising), you are left with a very gentle removal of accommodative monetary policy.

But now the Fed is telling us that policy is reaching a neutral zone at which point the impact on the economy is neither positive nor negative. In other words, Goldilocks has entered the bears' cottage and is feeling right at home.

The Fed's tone suggested that more interest-rate increases were on the horizon. But the stronger message was that the top of the hill is in sight. There won't be too many more rate hikes.

That's why I was surprised that the bond market was a little slow to get its act together following the breaking statement.

When the rate plateau becomes apparent, the market starts to take for granted that the next move will be downward. At the very least, traders start to assume that there is some relief in sight and that the downside risk has become limited.

Longer-term investors start to reverse long-held views that the bond environment is negative - so they start to cover positions.

Only after an overnight pause did that idea become entrenched in trader psychology, but it could be the start of a bold upward surge in bonds, at least until we see firmer data.

Of large concern to the Federal Reserve has to be the real estate market. Since the equity market peaked and the recession ensued starting in 2000 money has poured into housing sending prices surging.

House prices have surged and mortgage lending has gone through the roof. Equity withdrawal has carried consumption throughout the recovery, aided by a 46-year low in interest rates.

The Fed will want confirmation that this housing boom is tapering off. And there is some evidence that this is indeed happening.

Existing home sales are showing signs of slowing - although there has been a crescendo during the tightening phase.

While sales of new homes continue to escalate, it's possible that the building boom might have peaked. According to construction data, that high point occurred in February 2005 and there has been a 10% decline in activity since.

The big question here is: How much does the Fed want to control the real estate market?

By many estimates, housing prices are out of control. Far too many speculators are spoiling the party for legitimate house-buyers and apartment-dwellers in the hope that they can flip property for a guaranteed profit.

But if it fuels consumption and it feeds confidence, the Fed had better be careful with how far it lifts those rates!

I believe the Fed statement also sent an important signal regarding energy prices. Previously it has discussed the inflationary threats from rising energy costs.

Yesterday's statement screamed change to me when I read it. The wording discussed "elevated" energy prices.

Now, that might not send the same message to you, but as I read that point, something clicked. The Fed realizes that, just like interest rates, energy prices have possibly topped out. The hurricane-inspired surge to above $70 per barrel of crude oil marked a clear high-water mark for energy prior to the winter season.

Since then, crude has backed off to below $60 despite brutal weather at the start of winter.

Economists have noted that at around the $69-per-barrel mark, consumer confidence tends to buckle, thereby creating a built-in brake on the economy.

If global growth speeds up, rising energy costs will act to dent consumer confidence in the United States. At the same time, any weakness in bond prices (due to fear of rising interest rates) would slow the economy and also help us to self-correct.

Meanwhile, the Fed's action this week could be very bullish for bonds. They have admitted two things: Long-term inflation expectations remain firmly anchored, and growth is solid.

While it may be a long time before rates start to fall, bond buyers might not face much downside risk in light of these admissions.

Though they are unlikely to be on hold just yet, the flattening of the yield curve is correct to predict that there won't be many more rate hikes in 2006.

Shares in Altria Group surged 6% to an all-time high in active trading on Thursday, following a decision by the Illinois Supreme Court to overturn the decision of a lower court.

That earlier ruling said that cigarette maker Phillip Morris USA, a core part of the consumer-products group, had "intended to deceive consumers" about the associated health risks in its marketing of "light" cigarette brands.

The reversal of the decision will save Altria from having to splash out $10.1 billion in damages to consumers.

The Illinois Supreme Court's decision was based upon the fact that the Federal Trade Commission had authorized cigarette makers to characterize their products as "light" or "low-tar."

The move is also good news for R.J. Reynolds Tobacco Company and other cigarette makers who have similar suits lodged against them in Illinois.

Two years ago, Phillip Morris admitted it was staggered by the court's decision - one that could have caused the company to declare bankruptcy.

Just to illustrate the scale of the problem, in 2004 the company earned $9.4 billion in net income.

While shareholders clearly welcomed the news, Altria's long-term ambition to split the tobacco and food divisions of its business still depends on further pending legal news.

In Florida, the company is still appealing a $145 billion punitive-damages verdict that resulted from a class-action suit brought by smokers.

Have a great week! 

Andrew Wilkinson


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Dear MoneyNews Reader, The NewsMax office had the distinct feel of the holiday season in the air this week. And with good reason too. Early in the day I stopped by a local Starbucks and treated myself to a gingerbread latte. No sooner was it in my hand than I caught the...
Friday, 16 December 2005 12:00 AM
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