Much has been made about the lack of volatility, relatively speaking, across almost all parts of the capital markets. The dampening down of what would be considered normal volatility has again been laid at the feet of the command and control Central Bankers.We are not surprised however as the prevailing attitude is that low rates cure all ills, when in reality, low rates create more ills.  We all should be quite attuned to the sedative effects of low interest rates on investors perceptions of real risk, if the recent crisis has taught us nothing else. Thus, when we see potentially serious geo-political flareups such as Iraq or China/Korea, any hint of serious concern is smothered quickly by the “whatever it takes” mentality inherent in  all Central Bankers. However, as Bertolt Brecht said ” Because things are the way they are, things will not stay the way they are”.

I have to put us in the dumbfounded camp when it comes to the recent action in Treasuries. Yields that are scraping along the bottom, actually negative real yields if you take the most recent CPI data and a sub 2.5% Ten Year Note, would not seem to jibe with the action in Global Equity Markets. It’s hard to imagine that  the equity markets and the fixed income markets both have it right. The explanation for the aforementioned Treasury rally has been laid at the feet of outright deflation, ostensibly exported from the newly submerging markets (China, Brazil, etc..). The geo-political backdrop to a global macro environment that is still based on “beggar thy neighbor” policies would argue that there is less to this deflationary argument than meets the eye. David Rosenberg of Gluskin Sheff deftly points out that the newfound global disharmony, both politically and economically, will have vast implications for forward thinking investors. Mr Rosenberg comments ” Tectonic shifts are taking place and this in turn requires a shift in strategy for anyone operating under the old paradigm of world harmony, political stability, central bank prudence and expanding global trade flows”.The tectonic shifts for which Mr Rosenberg refers are the anchors of inflation/deflation and his argument for a pre-emptive shift in portfolio composition, in our opinion (obviously), is spot on. Position yourself on the right side of the tectonic plate and Buy Stuff. 

Anyone that has flown as of late knows the ticket inflation that has infiltrated almost every part of the traveling experience. Charges for baggage, change fees, beverage fees, overhead space fees, etc.. We have always wondered out loud how a flight to Florida from Chicago could be profitable at peak travel times for $100 round trip. Well, it turns out it wasn’t, and a Bloomberg article astutely points out the somewhat counterintuitive notion that high oil prices are actually the culprit for a turnaround in the profitability of the U.S. airline industry. In spite of fuel costs doubling over a 10 year period, airlines are on track for a record fifth consecutive year of profits. The reason for the profitability increase was that airlines not only became more lean and mean, flights were  finally rationalized and thus consumers were forced to allow the airlines to charge more. However, most importantly the relatively high fuel cost made starting a new airline cost prohibitive thus finally driving bottom line growth in an otherwise unprofitable schizophrenic industry. We have to wonder if this industry example can be extrapolated into other industries where high commodity costs and low barriers to entry have led to great benefits to the consumer, but low to stagnant profit growth afforded to the producer. More stable profit growth means more stable underlying commodity demand and a compression of the amplitude of the boom/bust cycle that plagues all commodities. This type of shift would ostensibly bring smiles to Central Bankers faces everywhere.

The most recent Fed minutes came out and we were surprised to see the consternation amongst some Fed Members regarding the downward trend in medical costs. The concern was voiced in the context of a discussion on the decelerating overall price level. Some of the voting members were optimistic that wage growth momentum would be positive for inflationary pressures moving forward, but it should bother everyone that falling medical costs are a concern of those around the Fed meeting table. Correct me if I am wrong, but as I stated in our last post, the goals of monetary policy seem to have shifted towards the touchy-feely variety and as such it would seem that falling medical costs might benefit those that Chairman Yellen seems to be most worried about. Chalk this discussion up to one more example of: Be careful of what you wish for. If Central Bankers are becoming concerned, and thus forming policy decisions, based on naturally shifting price data (some go up some go down), it would seem only natural that they miss the forest for the trees. Particularly since history has proven that their forecast usually misses both the forest and the trees. Pay attention to the forest. Buy Stuff Sell Paper