QE2, Inflation and the Great Margin Squeeze

Don't confuse speculation with inflation

Global food prices are soaring. Market speculation fueled by QE2 as well as one-off events like the Great Queensland Floods in Australia and US subsidies for ethanol have driven up prices from coffee beans to prime beef, from coal to corn, and just about everything else. The WSJ reports that eateries have little pricing power, so they have to scramble to avoid a big margin squeeze.

Mish takes it a step further, noting how commodity prices have increased across most industries, especially driven by oil and energy prices. Finished goods prices rose 1.1% in December, driven primarily by a 3.7% increase in energy inputs. Finished food rose 0.8% while wholesale inputs rose 23%. Mish concludes that "every step of the way, a decreasing portion of costs are passed along."

• prices are up 15.5% for crude goods
• prices are up 6.5% for intermediate goods
• prices are up only 4% for finished goods

Even less gets to consumer prices. The great margins squeeze is on. And the rise in oil could scuttle the recoveryless recovery. (Picture courtesy Pierre du Plessis.)

This is NOT inflation. Inflation is a general rise of prices, whereas this is a rise among commodities but not end prices or wages.

Let me use an analogy. A while back I discussed "good" deflation vs "bad" deflation. The steady drop in HDTV or PC prices is an exemplar of good deflation - price drops due to the ruthless pursuit of productivity and efficiency. A general drop in prices is a symptom of bad deflation - the rise in the purchasing power of the currency. Good deflation can continue for years in certain factors of production - such as oil in the 1890s, autos in the 1910s, PCs in the 1990s and HDTVs in the 2000s - without in any way presaging or sparking bad deflation.  

Similarly, a rise in classes of prices, such as commodities, is not the same as a general rise in prices. The commodities rise is likely to spill over into inflation gauges, such as the CPI, as energy and food prices tend to get passed through. But the core CPI - excluding food and energy - is unlikely to budge much. This commodities bubble echo (an echo of 2008) can continue for months without causing or presaging any general inflation.

When it bursts, it might paradoxically accelerate deflation. In our economy, debt creates money, and commodities speculation that uses margin piles on more debt. As the positions unwind, the margin is paid off and money disappears. If the effect is large enough, it can lead to deflationary pressure. 

This is not to downplay very real inflation outside the US. China in particular is seeing the inflation monster threaten to swallow their economic miracle. Some argue this Godzilla is caused by Bernanke and QE2, and certainly the commodities bubble contributes to inflationary pressure inside of China, but the source of Chinese inflation is much more prosaic: their money supply is growing too fast, fueled by a credit bubble from Chinese banks, not the Fed. Chinese M2 is up 55% in two years, and its PPI is up 5.5% year over year. Chinese steps to quell inflation have been tentative so far, as they seek that elusive "soft landing." If inflation crests double digits, they may need to find their own Chairman Volcker to slay the inflation beast. Andy Xie, one of the best observers of Chinese financial markets, suggests that China may need to devalue the Yuan, slowing capital inflows and likely causing internal interest rates to rise. 

What the Great Margin Squeeze means going forward is pressure on domestic US profits, headwinds from rising oil prices, and the possibility of a bursting Chinese credit bubble shocking world markets.

Comments

[Hockthefarm]

Wave:

"this is nothing but a possible trade out of a stalled market that may or may not happen. like it might last 2 days of 10 days or 2 weeks ,,,, who knows ,,,, it's just overbought and can stay that way for another 5,000 or 10,000 points.

still way out bullish."

You have been bullish for some time. I think you have the correct pulse. I've been waiting for a pull back to jump in. Still think we get one but who knows? Dent sees a 5 percenter coming and is telling folks that it may be a good, long entry point. Sy Harding is looking for a sharp, short pullback. Feb is usually the weakest month of the favorable season so I'll give it another month or so, but definitely want my 401k working for me for a good chunk of this year.

H

[Wave Rust]

hock

lots support points between spx 1294 and 1271. the drop off the close isn't very nice looking. but get below 1271 for a while with no real bounce, and i can see 1200 real fast.

it will have to be fast or else the dip buyers might save it around spx 1240.

i don't know what yel sees, but i agree with his line of thought.

take a look at the steady drop off from the close. small gap and then just sneaking on down.

all i lack is a sell and i can't find one ,,,, yet. :)

break 1290 with some mojo and i might jump in.

just sittin patiently watchin. i'm not much of a front runner. been run over enough times and know better. :)

might go higher before it goes lower

wave rust

[Hockthefarm]

Wave:

You may find this interesting:

http://www.healthywealthywiseproject.com/Home/wealthy-blog

Tom Demark is looking for an 11% pullback that should start within 2 weeks. I'll probably start legging back in (say 20 % at a time) if we cross the 5 to 7% range. Historically these pre-election years have been pretty kind.

Hock

[Hockthefarm]

Peak Oil gets kicked down the road 20 years:

http://tinyurl.com/4n5d45q

Hock

[yelnick]

Wave I don't see anything other than a three day plateau. my fractal finance model in any event does NOT try to catch a top, but catch a trend change after it starts. there is a Fib level at 1306.

where I see bigger issues is when QE ends. So let's put the week of June 13 on the radar screen.

[emma]

Alot of people think we are doomed, but there are still great ways to make money. Even while the economy is collapsing around us.

I subscribe to the guy from australia and his FFT economic newsletter at http://www.forecastfortomorrow.com that guy has called many big events before they have happend, including the stock market crash in 2008 and the current financial collapse of the US. (currently happening) I found him from a friend last year, and he has some important work.

His oil calls are insane, and I have been making good money with them. He is well worth a look, if you want to keep two steps ahead of the sheeple out there.

I am worried about my financial future. Is anyone else nervous out there?

[Account Deleted]

Dow Jones Futures hour chart
http://niftychartsandpatterns.blogspot.com/2011/01/dow-jones-futures-in-rectangle.html

[Hockthefarm]

I gave up the fast food a few years back. Usually can find a subway in a pinch.

Two questions for this industry:

What is in it and who is cooking it:

"Taco Bell quickly denied the accusation. "The lawsuit is bogus and filled with completely inaccurate facts," Taco Bell President Creed said in an interview.

The lawsuit, filed by the Alabama law firm Beasley, Allen, Crow, Methvin, Portis & Miles, doesn't specify what percentage of the mixture is meat. But the firm's attorney Dee Miles said the firm had the product tested and found it contained less than 35 percent beef. The firm would not say who tested the meat or give any other specifics of the analysis.

Taco Bell says its seasoned beef contains 88 percent USDA-inspected beef and the rest is water, spices and a mixture of oats, starch and other ingredients that contribute to the "quality of its product." The company said it uses no extenders."

Hold the digglers,
Hock

[MT]

Here is the spike, if S&P closes under 1300 then monday is a panic day

[Leon]

MT, I doubt it. Panic days are rare.

[Mamma Boom Boom]

>This is NOT inflation. Inflation is a general rise of prices, whereas this is a rise among commodities but not end prices or wages.<

I agree 100%. But many will disagree. I have always considered that inflation is impossible without wages. Prices can go up but will soon fall when people quit buying.

[Mamma Boom Boom]

wave and hock, we have a horse race. We'll know who's right soon enough, you or me.

[Mamma Boom Boom]

Think what life would be like without all the silly government agencies like the FDA. Attorneys wouldn't be able to file frivolous lawsuits against Taco Bell.

[Hockthefarm]

Peanuts, get yer peanuts. Eggs too!

H

[MT]

The reversal started today. 10% down into march

[Hockthefarm]

"The reversal started today. 10% down into march."

That would be perfect.
H

[Wave Rust]

mamma.

you don't get it, do you? If you think there is a race with me, you're racing by yourself.

it's not anything about being right either, at least for me it isn't.

it's only about being profitable safely. that means low risk trades with 3 or 4 to 1 profitability possibilities.

I couldn't care less about being right. this isn't a competition versus other blog commenters.

for me, it's about trading. period.

I have my outlook within a trading perspective. I don't post my trades because it screws up people if I change my mind, and then don't post that change.

Being right is irrelevant. Being safely profitable is, and it's the only thing.

wave rust

[Account Deleted]

Crude Oil Chart: http://niftychartsandpatterns.blogspot.com/2011/01/crude-oil-rises-from-trend-line.html

[Wave Rust]

yel,

fractal fin. and bifurk's is it? okay then. we're definitely looking at different things.

the set up looks exactly like the april 2010 crashette, but so far today, i don't think it's the same degree ,,,, a lower degree is my guess ,,,, especially if 1270's hold for a day or two. spx 1240 is the possible lynchping.

this isn't your Flash Crash II though. This is maybe the "Cairo Crash". LOL

if spx pings it and bounces then this whole correction is probably just a complex 4th (flat) or D from the august low. This early flop is then just setting the trading range for a couple weeks ,,,,

I think i mentioned a few weeks ago that mid-February was a buy. so we'll see 'in the fullness of time' (Ed Hart) :)

------------------
As for June and the "death of the QE's" ,,,, i'm down with that too! :)

listening to Buffet on my 8-track ,,,, "Pirate Looks At 60" ,,,, after his 6 ft. fall!!

"Hey, Jimmy, get some glasses!"

wave rust

BTW, I'm back in cash ,,, for the moment. Ain't greedy

[Mamma Boom Boom]

Cheesh wave, we're only down a few points and already you're getting 'ouchy'. (nic..nic)

[yelnick]

wave, we have bifurcated into a prior trading range/plateau, but not below. So it raises a red flag but we need to bust below 1280 and stay below to confirm a major change of trend. If you peruse the market since its last thrust (from Jan7 to Jan15) you see the plateau is between 1290 and 1280 with a false break below and now one above. The setup is for a reversal back to 1290 but NOT break thru, followed by a drop again where we test below 1280. Then we shall see. If we just crush below 1280 today, next week would predict as a bad week, dropping down below 1260 at least.

[Virgil]

Yelnick - I would say today's drop is a sharper downward pitch than the other's in your plateau. I think that was one of your & DG's cardinal requirements.
Did we ever hit the .707 retracement? I remember you laid out where the main bifurcation points were but I can't seem to find them in the search.

[Wave Rust]

Yel

now I see and understand your plateau

i call it something else but it is a heck of great day and swing trade set up ,,,, i use it all the time. there have been a series of them on the way up from March 09.

it only has false breaks about 25% of the time if you use flex params and demand a clear breakout ,,,, that is, emphasis on proof of the break ,,,, then jump in.

spx 1258 is december 31 close, so monday might keep the positive january=positive year "wive's tale" alive.

closing on the low tick of the day is good for a pop on monday.

but the 5minute looks like just a B wave bounce of the higher degree A of this correction. the A might stretch out till late next week. then the higher degree B which will start slow but really catch a burst to 62% retrace in its c wave.

then the C wave down ,,,, and thats when 1225 could get a ping into mid February ,,,, thats just my early polaroid of the horizon.

wave rust

[Wave Rust]

mama
like i said, you don't get it

wave rust

[Chabazite]

Mamma - You are my idol. Go on - hit me with it. How many points are we going down on the S&P till this bottoms? (Oh, please don't tell me stories about things feeding on Salmon. I am a simple soul and much gets lost in the translation between Floridian and English. Numbers will do just fine). Chubby Chabby :)

[Virgil]

> "but the 5minute looks like just a B wave bounce of the higher degree A of this correction"

That's a good call. If that B broke as 3 waves & its done then C equaled A

[Mamma Boom Boom]

wave, I get it, I'm just having a giggle.

Chubby Chabby, that's a toughy. I have said that there's a good chance we take out the 666 before this bear market is over. But, that could be years. Maybe this leg only takes us down to 900 by mid to late summer. I really have no idea. I just follow the tea leaves.

One would think we would get a bounce off 1225, but I'm skeptical. These rigged markets just don't work that way, anymore

Neo-Mamma

[Mamma Boom Boom]

Some day you guys will believe me about our 'Treasonous' politicians:

http://www.youtube.com/watch?v=gu5l7a7dgP4&feature=player_embedded

[yelnick]

Virgil, you asked about bifurcations moving faster than the prior trend - that is a requirement, which we hit today - and the levels to watch. You can also add wave's comment below yours about the swing trade for day traders - same basic pattern.

The retrace levels are measured from bifurcation to bifurcation, a different approach than orthodox wave theory which tends to count from tops and bottoms (except with irregular flats and triangles). The bifurcation approach is much simpler to get right, since it almost always removes the subjectivity of when one wave ended and another began. Under this approach, the Mar6 bottom was clear, as was the Jul2 recent bottom; but the top of the April move happened in early May, after the nominal top.

You will find that the 1303 bifurcation moment today is very close to the 70.7% level counting from the 2007 top to the 2009 bottom:

1576 to 667 = 909
667 to 1303 = 636
636/909 = 70%

1310 would have hit it spot on.

One more step: when did the bifurcation off the 2007 top occur? While 1576 is the intraday top, the first bifurcation was several days later, on Oct15 at 1565 intraday, when the market fell off the plateau around the peak. If you look at the pattern, a clear trading range from 1548 to1565 with a false break to 1576. Recalculating:

1565 to 667 = 898
667 to 1303 = 636
636/898 = 70.8%

[da bear]

Great, soon we won't be able to afford Taco Bell.

da bear

[yelnick]

da bear, I will post on the Big Mac Index shortly. A friend of mine saw a $7 big mac in a US mickey D's.

[Mamma Boom Boom]

Bears kickin some booty, here in the last hour.

[JT]

Market will find support above 1261 SPX early next week and will be a BUY!

[Ray]

Yelnick, that's interesting data, but based on this, what do you project going forward based on this 1303 number? 1303 could be a top if QE2 is it for the Fed, otherwise we'll go much higher from here. Ray

[Mamma Boom Boom]

I predict that later on, this year, JT and Michael will be offering to do odd jobs for you: like polish your shoes or rake your leaves.

[Hockthefarm]

Crude Oil Chart:

The oil industry is starting to get that 1980's feel:

Piling on the regs.

US has gas coming out its ears.

No crude shortage for 20+ years.

Industry could be set to double dip.
Hock

[Roger D.]

Today was a good day. I hope everybody got out while the gettin was good. Next stop 1250 and later is 1040. The DAX formed a high right shoulder,the exact same pattern that AZO formed. The market will loose 10 pct in the next 4 days. Have a great weekend.

Roger D.

[Chabazite]

Mamma - stellar Mamma

[time to get long]

Roger,

Your latest misspelling-rich post helps to persuade me that this drop will soon stop and reverse course.

You may now rewind and press play, repeating ad infinitum.

[Michael]

Thanks for your support Mamma Bong Hit.

But you have no freaking idea what you are talking about when it comes to traders such as myself who trade the COAL and resource sector. No clue at all. Were you long MEE or ACI or ANR or PCX today like me?

Probably not.
You are a poser dude.
You've probably never traded a stock in your life.
Now go back to class and stop wasting your parent's tuition money!

[MT]

JT what makes you so confident about 1261? I foresee at least a decline of 10% this time. But every time when Roger shows up we go the other way. Only joking Roger, nothing against you.
The only reason what makes me not comfortable is that to many are seeing the same.
I use 3 reliable formula's wich pinpoint last week the spike today and the start of a decline. Let's see what next week brings, but I'm curious about your 1261 target so if you want to share... thanks

[Mamma Boom Boom]

Lot's of carnage!

I think by the middle of next week, most people will start to squirm in their seats.

[yelnick]

Ray, I have not yet pulled the fractal finance work into a coherent theory, so take this as very raw.

First, we closed today below the recent trading range, which suggests a move down to the next level. It would have to reverse quickly Mon am and stay above 1280 to wipe off this signal.

Second, the next step down is the larger range at the end of Dec right below 1260. JT's 1261 would be a stop right above the range, indicating that the trend would reverse back up. I think, however, that if we head to 1260, we are heading much lower.

Third, the major test will come at the Nov range between 1180 and 1200. A break of that and we are going down to 1040 range. More likely we bounce off those levels and retest 1303 by June.

Longer term, this market still seems poised to rise until the end of QE. I put the time frame for an end out into mid June, using the June 13 week as a key week. A lot of events may come to a head that week, including China and commodities.

In FF, there is no decent level after 70.7% other than 78.6% which is a Fib level of some note; but Zoran found it less useful than Prechter does. Prechter says, rarely does a wave 2 get to 78% without going all the way above 100%; Zoran says rarely will a wave 2 pass 62%, and almost never does a break of 70.7% reverse before hitting 100%. Hence if we pass around 1306 +/- (say 1303 to 1310), the next stop is the 100% level, or back to near the 2007 highs, with a possible reversal at 78%, or around 1375.

[Hockthefarm]

Could get interesting if the materials sector breaks through its 50 day:

http://stockcharts.com/h-sc/ui?s=XLB&p=D&b=5&g=0&id=p51802365569

One more lunge should do it.

Hock

[Hockthefarm]

Go Corrigan!

[Must have been written by Ewave Genius]

"Prechter says, rarely does a wave 2 get to 78% without going all the way above 100%; Zoran says rarely will a wave 2 pass 62%, and almost never does a break of 70.7% reverse before hitting 100%."

[Hockthefarm]

da:

"Great, soon we won't be able to afford Taco Bell."

That could be a positive. 35% meat. Fluck me, that is worse than the chili finger. Next time my kids want taco bell, they are going to walk.

Hock

[MT]

Monday Spx hits 1270, from there a swift bounce to 1288, let´s say within 3 day´s.
From 1288 the dumping starts to the 1160 zone. This level is important. If here is the bottom and big boy´s are willing to buy again, decline is over and by mid year we are up to 1400+
A larger correction is not possible at this moment to salute new highs this year. If price penetrates 1160 by more then 2,5%, the retest of the 2009 low is underway. For me 1160 is the line in the sand.
We had already a big decline at april '10 so a new decline of the same magnitude in such a short time is not possible, only bigger.

[MT]

JT, I tested your 1261 scenario and it failed. In the 1270/1263 zone monday, yes a bounce starts. The pattern and formula's this month showing me a pattern wich in the past pinpointed big declines with a very high accuracy. I don't know where this decline bring us, but the first stop should be the 1220/1200 area. If this is the bottom, it's only a correction of 6%. But your 1261 will be smashed after the bounce.

[Account Deleted]

US Dollar chart: http://niftychartsandpatterns.blogspot.com/2011/01/us-dollar-rises-from-golden-ratio.html