Good Economic Times Are Back ... Think Again!

Tony Sagami

The United States created more than 200,000 jobs in March and pushed the unemployment rate down to 8.8%, according to the Labor Department.

On top of that, the stock market ended the quarter with a bang and ended up as the best first quarter for stocks in 12 years. The Wall Street crowd was impressed and seems to think good times are here again.

But I don’t think so!

If you’ve read my column for very long, you know I’ve been harping about the dangers of inflation. At the expense of sounding like the boy who cried wolf, the warning signals are getting louder.

Maybe I’m just a loud mouth with a couple hundred thousand readers, but one person on the consumer frontlines who probably knows better than anybody else is Wal-Mart CEO Bill Simon.

As head of the largest U.S. retailer, Simon is in a unique position to see firsthand the effects of inflation traveling through the supply chain.

That is why I paid very rapt attention to his warning last week that inflation is “... going to be serious. We’re seeing cost increases starting to come through at a pretty rapid rate.”

Simon also warned that Wal-Mart will soon pass higher costs on to shoppers. This is the tip of the iceberg.

Here are some examples of price increases from other companies:

  • Hershey, the maker of Kit Kat and Reese’s Peanut Butter Cups, announced that it will raise the prices for most of its candy products by 9.7% to cover rising raw material costs, fuel and transportation.
  • The price of coffee has nearly doubled in the last year, reaching a 14-year high. In response, Starbucks raised the price of its packaged coffee products by 12%.
  • Nike announced that it will raise the price of its shoes by an average of 5.2% due to rising prices for cotton and rubber.
  • Instead of raising prices directly, Kraft Foods is responding to rising costs with smaller portions and reduced serving sizes. A Kraft American Cheese package, for example, now contains 22 slices instead of 24 slices. That’s the same as increasing prices by 8.3%.

U.S. Inflation on the Rise

The Consumer Price Index rose at an annualized rate of 2.1% in February (the most-recent statistics available), according to the Bureau of Labor Statistics.

Fresh vegetables and meats rose the fastest, and dairy products are at their highest level since 2008. Fruit is up 10.6%; pork up 9.9%; ground beef up 9.9%; and potatoes up 5.9%.

The short-term picture looks ever more worrisome. The annual rate of price change for the six months ended in February was 3.9%. Using the last three months, the annual rate of change is 5.6%.

Conditions will get even worse now that oil has crossed the $100 threshold and looks to stay high — if not move higher — because of Middle East unrest.

The national average for a gallon of gasoline hit $3.61, but it’s even higher in some parts of the United States, according to AAA. Gasoline prices in California, for example, hit an average of $4.04 last week.

Gas prices are roughly $1 a gallon higher than they were a year ago, and since the average American family uses about 1,200 gallons of gasoline a year, that’s an extra $1,200 a year out of their pockets and a major hit to household budgets.

Consumer Confidence Takes a Hit;
Higher Interest Rates Are Coming

All this inflation is eating away at consumer confidence. The Conference Board’s Consumer Confidence Index fell more than expected in March to 63.4 from 72.0 in February. A reading of 90 indicates a healthy economy, so we are way below that benchmark and ready to go even lower.

I say “lower” because the Federal Reserve Bank will soon be forced to adjust its zero interest rate policy to battle the inflation problem it caused with absurdly low interest rates and money printing.

Two of the Federal Reserve Bank officials are giving clear advance warning signs. Richmond Fed President Jeffrey Lacker said in a CNBC interview that he “wouldn’t be surprised” if the central bank raised interest rates by the end of the year.

Minneapolis Fed President Narayana Kocherlakota told The Wall Street Journal that benchmark borrowing costs could rise by three-quarters of a percentage point by the end of the year.

The big Wall Street money already knows this. Treasury bonds suffered their second quarterly loss in a row. Treasury bonds lost 0.1% in the first quarter of 2011 following a 2.7% drop in the final three months of 2010.

Bill Gross, who runs the world’s biggest bond fund at Pacific Investment Management Company (PIMCO), warned that Treasury bonds “have little value.”

Warren Buffett feels the same way. “I would recommend against buying long-term fixed-dollar investments,” he warned during his March trip to India.

How To Play Higher Interest Rates

How can you make money if Gross, Buffett, and I are correct about interest rates? There are several options to consider:

There is a special breed of bond funds that are designed to make money when interest rates go up:

  • Rydex Inverse Govt Long Bond (RYJUX), for example, aims to deliver the inverse return of a 30-year Treasury bond.
  • ProFunds Rising Rates Opportunity (RRPIX) sets 125% of the inverse of the long bond as its goal. Warning: both of these funds will lose money if interest rates actually decline.
  • There are several exchange traded funds that also profit from rising interest rates: iPath U.S. Treasury 10-Year Bear ETN (DTYS), iPath U.S. Treasury Long Bond Bear ETN (DLBS), and ProShares Short 20+ Year Treasury (TBF).
  • And if you really want to make an aggressive bet that interest rates are going to rise, you could invest in a LEVERAGED INVERSE exchange traded fund such as the PowerShares DB 3X Short 25+ Year Treasury Bond ETN (SBND) or Direxion Daily 30-Year Treasury Bear 3X (TMV).
  • More conservative investors could look at Treasury Inflation-Protected Securities or TIPS, which are bonds that adjust their interest rate every six months, according to fluctuations in the Consumer Price Index (CPI). A TIPS bond fund will perform well if both interest rates and inflation are on the rise.

Funds to consider are: Vanguard Inflation-Protected Securities (VIPSX); American Century Inflation-Adjusted Bond Fund (ACITX); Fidelity Inflation-Protected Bond (FINPX); and T. Rowe Price Inflation-Protected Bond (PRIPX).

I’m not suggesting that you rush out and buy any of these ETFs or bond funds. As always, you need to do your homework and decide whether any of them are appropriate for your personal situation and financial goals.

And as you know, timing is everything when it comes to investing, so you should wait for these to go on sale before jumping in.

Best wishes,

Tony


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Posted 04-09-2011 11:59 AM by Tony Sagami