1 – Recent Developments & Impacts on the GaveKal Investment Scenario

Six months ago, the US was experiencing a ‘soft patch’ that many feared would turn into a ‘double dip’ recession. And with core price measures already quite weak, there were renewed fears of a deflationary spiral. Inflationary expectations according to TIPS were falling fast. In response, the Fed stepped in aggressively, providing QE1.5 in early August, and then talking up QE2 in late August. Inflation expectations started to recover, and are now back to more normal levels—with five-year expectations back at about 2%, and l0 and 20 year expectations back to around 2.5%, in line with the boom years of 04-07. And the TIPS market may indeed be right, as we are already starting to see preliminary signs of rebounding pricing power in the US:

·         Are Manufacturers Starting to Have More Pricing Power? Material input prices have been rising in line with commodities, but until now manufacturers have been unable to pass much of those price increases on (and instead have squeezed everything they could out of their workers, as evidenced by the recent spike in hours worked). But with the NY Fed survey released yesterday, it seems manufacturers are starting off 2011 with some price increases and are much more confident that they will be able to increase prices over the next six months (see chart on p. 2). This stronger pricing environment could trickle down the supply chain and spread throughout the economy. The NFIB small business survey has also exhibited rising price expectations (though the current price index is not yet in positive territory—see second chart on p. 2). If they can in fact start getting higher prices, they may be more inclined to hire more workers, which will improve the employment and income situation and in turn support consumer prices.

•       Is it a Coincidence that Import Prices From China are Showing Life at the Same Time? In the last couple months of 2010, US import prices from China have started to rise YoY for the first time in over a year (see green line in chart 2 and yesterday’s China Trade Review from Dragonomics). And one can find similar increases in pricing power from other major exporters to the US (e.g., Mexico). If China & co. are starting to increase prices, this may give the US producers more breathing space to increase prices as well; and of course vice versa. When Arthur was in Dallas last month at a breakfast with Richard Fisher, the regional Fed President noted that opening bids for supply contracts from China for Texas firms were typically up +20-30% over last year. This is clearly one of the data points that undergirds his very public inflation concerns (see speech here).

Now we are not fearful of runaway inflation anytime soon. Our point is only that there are increasing signs that the deflationary threat is largely behind us, and there are increasing signs of pricing power returning. And given our optimistic view on US employment and final demand, we think this will continue. If so, the view of Fed presidents Fisher and Plosser—who think the Fed should concern itself primarily with ensuring price stability rather than also trying to target housing and unemployment (see p. 4)—may gain ground. As both Fisher and Plosser become voting members of the FOMC this year, their contrarian views will have more clout. If the reader is like many of us here at GaveKal, and thinks that a) deflation is dangerous and to be avoided; but that b) the Fed and government have already provided more than enough stimulus to avoid deflation; and thus c) continuation of today’s ultra-loose monetary policy will contaminate the business environment with false prices and brew misallocation of capital… then one should see the recovery of pricing power, and the increasingly hawkish calls from some within the Fed, as bullish signs of normalization and for future growth (see Ricardian Growth, Schumpeterian Growth & the Cost of Capital).

 

 

2 — Are Consumers Ready to Pay a Bit More?

 

 

 

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