State Sponsored Inflation

UK CPI: Go Figure. In the UK, the Jan Consumer Price Index fell sharply from 4.2% to 3.6% (14Feb12). Food, clothing, and household goods fell, but the biggest contribution was the removal of last January's VAT (tax) hike from the calculation. (They raised it from 17.5% to 20%.)

Economists were pleased, predicting that as inflation falls,  the consumer will have more real spending power towards the end of 2012, which will get businesses investing. We can hardly wait.

Going forward, there may be another explanation for the CPI decline. Maybe consumers are spending less because they are taxed too heavily when they do. Just because the VAT increase falls out of the calculation doesn't mean it's not there.

And bear in mind, UK VAT not only applies to goods such as shoes and computers, it also applies to services such as accountants and builders. Did someone mention business investment?

Think of the converse. If a tax hike caused inflation, then a tax cut would lower inflation. This would make goods and services cheaper, which as the economists say, would get the consumer spending, and which would get business investing.

So instead of the Bank of England spending another £50 bil on quantitative easing, which largely goes to the banks, how about retuning VAT to 17.5%? Or do I hear 15%?



USD/JPY. Let's have a look at another FX anomaly, namely, the strength of the Yen vs the Dollar. USD/JPY has fallen to 78-79. The cause is generally seen as a result of the Fed's willingness to continue quantitative easing.

But after the tsunami, and considering that Japan itself has limited natural resources, why is it trading like a commodities currency? For example, the current AUD/JPY is appx 85, while the 3-yr average is appx 79. If anything, the Yen should be tumbling vs the Aussie.

And bear in mind that the US is now a net exporter of fuel (Wall Street Journal 01Dec11), which should give it support with other commodities currencies vs the Yen.

So is the Yen now the world's reserve currency? Not! To my mind there may be another explanation. What follows is cynical and unfounded speculation.

Suppose Japan were opposed by another country, one to whom they have been an historical enemy. Suppose this other country were an export competitor. Suppose this country were out to tackle and appropriate Japan's manufacturing capability.

Suppose this country for the first time in the modern era (if ever) owned a hard currency, ie, warehouses full of American dollars. These dollars could be sold to buy and support Yen. This would simply be a form of currency intervention, which all central banks do.

That's not to say that such intervention could compete against the global FX market, but it could exacerbate the long-term downtrend of Dollar vs Yen.

The result would be to increase the cost of goods manufactured in Japan, which would impede Japanese exports. If maintained over some years, this currency intervention might lead to Japan's downfall.

Maybe this is why the Bank of Japan, this past week, jumped on the quantitative easing band wagon by announcing a program to buy10 trn Yen of its government bonds. Effectively this weakens the Yen while circumventing the FX market.

Will this action be enough to stabilise USD/JPY? How far is the BoJ willing to go with QE? This year will be crucial for the Yen.


After the Noise. The US keeps turning out impressive statistics. I called for non-farm payrolls to reach +200k by March, but we got +243k in Jan! Meanwhile Q4 GDP was +2.8%. Jan retail sales were lackluster (+0.4% vs expected +0.8%), but this follows a respectable holiday season, where Dec11 sales were up 4.7% from Dec10 (ShopperTrak).

But another indicator, the bell weather of tech stocks, Apple, has reached $500 per share. Yahoo.

The broad rally in stocks has stalled just where I said it would. (For once I'm right.) Check out the SPX chart below. We still need to see if resistance at 1350 holds before looking at trade ideas, but, as I said before, the covered write is the preferred strategy for range-bound stocks that are long-term investments. More on this next time.

Nasdaq. Meanwhile, the tech-weighted Nasdaq is absorbing what liquidity is available. It's going through one of those scary rallies. Historically, the Nasdaq has been an inlet for hot money. (See the chart below.) Hopefully tech investors are now more level-headed than they were during the dot com era, but probably not. The stock market doesn't have a memory.

Still, there are bound to be future Apples out there, and it's great to see investors getting behind US technology again.

'Till next month, LJ

The Decline of Western Economies and The Rise of Western Values

Hello and Happy New Year. The big stories of 2011 were the decline of the Western economies and the rise of Western values. With the Euro on the brink of splitting apart, the US making strides but still deeply in debt, and Japan showing no sign of sustained recovery, the world witnessed the Arab spring, and mass demonstrations against Russia's Putin. Armed with mobile phones and the internet, people exercised freedom of speech and demanded the right to elect their leaders, and they began to claim their countries for themselves.

With such a global sea change, it's difficult to see how China can persist with policies of censorship and repression of human rights. If the present is any guide to the future, then soon these policies will backfire on China's rulers.

The Euro. One of the anomalies of the 2011 FX market was the strength of the Euro. With the turmoil over Greece, Portugal, Spain, and even Italy, the Euro should have crashed. But to me, the market is saying that there will inevitably be an exit by Greece, which may snowball into exits by Portugal, Ireland, and maybe Spain. In the end, that would leave a core of stronger economies in the Euro, which is a bullish scenario. So for now, think that bad news for Greece is good news for the Euro.

Outlook for Stocks. The recent rally in stocks is good news, and it makes sense for the reasons I stated in my last blog. In sum, there's good value in many stocks right now.

I suspect that the cause of the January rally is that investors who have cash to put to work are buying stocks. I also suspect that they are almost finished. Notice in the above chart that the spx is meeting resistance at 1350. This indicates that investors are not yet brave enough to push the market into new territory.

I don't like to make predictions, but my hunch is that after January stocks will settle into a range. Looking into 2012, there's too much uncertainty for stocks to begin a new bull market.

The uncertainty is as we know it: the Euro crisis, which will drag on for at least the next quarter or two, and then the forthcoming US election. Investors are generally cautious in the run-up to an election, and unless one candidate is seen as a shoe-in, then expect this market to go sideways for most of 2012.

The Trade. So if stocks become range-bound but still worth owning, then the trade of choice is the options covered write.

With this trade you own or wish to buy a stock for the long term. Currently, however, the stock is not making headway. So you write, or sell, a near term call (say, 60-day) that is 10%-20% out-of -the-money. You write calls only on the number of shares that you own. At the CBOE, for example, 100 shares cover one call.

Your stock ranges until the call expires, at which time you collect the option's premium. If your stock declines, then you collect your premium as a cushion. If your stock makes an unexpected rally then your profit is capped at 10%, but then you have a nice little earner.

This trade becomes even more profitable when the stock is paying a favorable dividend. I may be sticking my neck out, but once stocks level off, the covered write could be the trade of the year.

I'll have more to say about the covered write during the coming weeks, and I'm preparing a special slide lecture on it, which will be available for a reasonable fee. In the meantime you can get a head start by reading pp151-157 of my book, The FT Guide to Options. If you then have any questions, send me an email at lenny@lennyjordan.com

But as always, before you risk your money, please consult your financial advisor.

The Wildcard. Of course, if we go to war with Iran, then all bets are off, but then the covered write would be an even better play for stocks that decline to improved value levels while maintaining their dividends.

In Other News


2011 Fund Award. The award for the Most Profitable and Ethical Fund of 2011 goes to ... (drum roll) ... the Wellcome Trust. This UK charity earned 2% while the markets fell 3%. So with £13.9bn under management (that's thirteen point nine billion pounds) they earned appx £270m. During their last fiscal year they gave £602m to charity. (City A.M. 22Dec11). And their fund manager is ... (drum roll) ... themselves!

Serious Transparency. This past week, in an unprecedented change of policy for a central bank, the FOMC published the economic forecasts upon which it makes its rate-setting decisions. The FOMC stated that its economic outlook through 2014 called for its base rate, now effectively zero, to remain unchanged until that time.

Mortgages. So whatever you do, don't take out a UK fixed rate mortgage, says the Evening Standard's Nick Goodway (26Jan12). I agree. UK variable rates are currently at a substantial discount to fixed. With Mervyn King saying that UK inflation is coming down, and that growth will remain flat for the foreseeable future, and with the Fed's rate-setting power on hold, the best advice is 'don't fix it'.

'Til next time,

LJ