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Well we have just seen the best bounce in the US market for many months overnight.

In fact it was the best rally in almost 2 years !!


Dow up over 200 points and the NASDAQ index up even more in percentage terms.


So one has to question, was that the low we saw Wednesday for the US markets ?

Was that the low we saw in our markets with the index for the ASX 200 at 3960 ish ?


Both great questions and if we were able to answer these with any degree of certainty we all would be a lot richer.


After being a bear for a long time and almost picking the actual low on Monday, I am still not convinced we don't see the index and shares overall go lower over time. For myself the bounce on Monday to Wednesday for the shares I liked was massive. In some cases there were announcements in-between which helped the recovery off the lows seen early Monday morning but in a lot of cases there wasn't. When a share bounces from its low on Monday to a high on Tuesday or Wednesday that is 5% or in some cases 8 % higher than the low ... It is almost irresistible not to take the money and run especially when the underlying index has only rallied back 1.6% ........


Sure one could say they overdid the sell off Monday in almost pure panic but the bounce we saw in our markets in Australia between Monday and Wednesday was almost the opposite in some cases. Some shares like CSL which I liked went from around $30.30 low on Monday to $32.80 on the bounce ... That's 8.25% for a bounce. Sure CSL had been hammered more than others in the move down but there were a lot in the same sort of basket in the bounce, IRE $3.58 to its highs seen yesterday was around a 10% move and more than likely even more today.


Others with even quicker or larger bounces COA and PTD were partially due to decent announcements made in between ... But COA bounced within a day from being given and offered at $4.10 to $4.40 before drifting back off. PTD was given heavily down at 133 and 132 to bounce back on an announcement to over $1.50. Now the interesting thing about PTD is that at $1.35 and below it implied a P/E of around 10 ... And this is for a drug company. On top of this it had a share buyback scheme as well going on with over 6 million more shares to buy ... So how it has got down here in the first place was frankly beyond me.


Now today I am sure we will see more of the same. I doubt the ones I mentioned go too much further than the overall markets rise we see today.


Why I am cautious still is what in reality has happened to the numbers behind and driving these moves. The US market is where we have been taking our lead. Friday night the US had a shocker and that's what started it all, Dow was down 181 points. This was the third day in a row for the US market down over 100 points. Bottom line even after the rise of yesterday the US market is still down around 2.7% for the last 2 weeks. This bounce last night might have a lot convinced the worst is over. Myself I remain very cautious and back to almost all cash yet again.


A few concerns had been driving the US markets lower. One was the fear the Fed would raise rates again. Second was the fact that high oil prices would slow the US economy and lastly the US economy may in fact already be slowing down.


Now some of the slide from the oil fear has stopped. Oil hit US$49.70 briefly and the market settled around US $50.50 for a couple of days. So the market stopped looking at this factor. Whilst they haven't been looking oil managed to creep back up this week to US$54.20, but since the market has been focussing on other things this negative has been ignored for now. For myself that the market was unable to even break the US$50- level and close below there despite trying for almost 2 weeks has me thinking we are going to sit in this range if not higher over the coming weeks.


Secondly, the Fed and fears of the raising of rates have really taken a back seat especially with last nights move in the US. Maybe the move down was already overdone is what they are thinking. Personally I am not sure they are thinking at all. In reality the US numbers with regards to what the FED is going to do have been shocking. The CPI number the other night ... Core inflation was expected at 0.2 % and it in fact came out at 0.4%. Not something the fed would be at all amused about. Secondly the Philly Fed numbers out last night were shocking when we look at the implications for US rates. The US Federal reserves watches these numbers very closely and the Philly Fed numbers are a favorite of Greenspan's The Index as a whole was expected to drop to 10 from a reading of 11.4 the previous month, but instead the index rose to a whopping 25.4 which the US equity market focussed on and ran with the ball. The number to them allayed any fears about the US economy was slowing and they put there buying shoes on and pinned their ears back and just bought.


Now the really worrying number for me out last night was the Philly Fed's prices paid index.

This rose again by a massive amount. It rose by 20.8 points to 50.5 ... This is not good.


At present the US equity market solely is focusing on just one aspect of the picture, that being the US economy seems to be going along still with some steam. What I have taken from this week and I suspect the FED will do the same is the inflation numbers look ugly. When the FED meets next month the fear before the US non farm payroll numbers early this month was they might raise rates by even more than the 0.25% increases they have been going at. On the 1st of April the Non farm payroll numbers came out but were a lot weaker than expected so the market pushed that fear aside. The headline number was 110k and about half the expected rise. In complete contrast the overall unemployment rate fell by more than expected.


The April numbers come out exactly in 2 weeks on the 6 Th. May. Personally all the numbers I have seen point to a higher number and a correction to the low initial number reported on the 1st April. The question for me is not whether the FED will raise rates in the US again but by how much ? The set of inflation numbers just out leave little doubt they will move again and even now I suspect the move will be 0.5% unless the numbers get a lot weaker between now and then.


Maybe the US equity markets claw back some more of the losses seen over the last 2 weeks but the writing is on the wall for another rise in US rates and I for one am leaning towards the 0.5% as opposed to the 0.25% rise. For us in Australia I don't think this means we follow, the rise we had really put a big dent in the economy and especially confidence and housing sectors. Not sure another rise would be at all productive.


For myself I remain very cautious as time goes on. Never been a real big fan of raising rates to counter inflation especially when the overall economy is slow or sluggish. When they raise rates I just think this adds to the whole inflation problem, the higher cost of borrowing/financing is eventually passed on to consumers as the producers have to adjust their prices to take into account the new increased cost base. With the oil price still up here and probably from the looks of it not likely to go much lower the increased cost on that side will also be passed on. If the US fed does raise rates just adds more pressure to the whole spiral.


Having been around when we saw rates raised several times in various cycles since the early 1980's this time I am not sure it is the right move. Back then the economies were motoring along and they needed slowing ... This time I am not sure it is the case. Still lean towards the view they are playing with fire here. Higher energy and higher interest rates are both negatives for an economy and take money out of it, worried some day it will just turn around and we will see GDP growth negative or sluggish with higher than normal inflation ... That being stagflation.


Over the last 15 years we have both enjoyed basically falling interest rates and low and almost steady energy prices, times have changed and I believe once we start seeing both go up one feeds off the other and we see higher inflation partially being driven by the rate increases that are meant to be keeping it down.


Who knows ? Just my own feelings from here. Suspect the US will start to focus on the rate side especially as the non farm payroll numbers get closer and the FED meeting in May. Myself I expect the non farm numbers in 2 weeks to be 250k plus and an upward revision to last months 110k number to around 148k if not more.


Not really tempted to chase the ASX 200 up from here for this reason. US markets could turn on a dime if they start focusing on the implications provided by the inflation numbers over the last few days.


Then again maybe I have yet again taken the money and run when the initial positions were the absolute lows to be seen in this move. Thats all the fun of being a trader, some you win and some you loose, but can't go broke taking a profit on a superball bounce.


Good Luck

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Hey, Kahuna.


I actually think that stagflation is really a relic of the 70's. Stagflation was in some part a product of inflexible labour markets: labour markets today are much more flexible.


No, I think the biggest danger the US faces today is actually deflation: I can't help but think that the US is sitting today around about where Japan was sitting in the late 80's. As you know, Japan has suffered from around a decade and a half of deflation, after being branded in the late 80's the 'miracle' economy.


So what makes the current US like the 'old' Japan? One thing is that Japan was unable to get its citizens to 'spend' their country out of the deflationary spiral. Asians are typically net savers - and it is true that Americans are the exact opposite. But the thing is is that American's consumption will at some stage have to turn - the Yanks will have to start to save, and will have to cut down on their consumption simply because you cant just keep on running up debt. So America in the near future will be like Japan in this: they will have to stop spending and start saving.


Similarly, the US government is at the same level as its constituents: it has a massive ballooning debt that will only be curtailed by massive cuts in expenditure. The effect on demand both in the US and abroad will be a large one.


The US is also like Japan in that it has massive structural deficiencies in its economy: low interest rates have fueled a channeling of capital away from expanding productive capacity, and into speculative bubbles like property. This leads to another similarity that US has to the Japan of the 80's and 90's: a banking and finance sector that will require massive reform. In the US the banking sector will be hit by a lot of dud loans that only become apparent as interest rates rise. There will be 'forced' reform on the US finance system - higher interest rates will be an emetic that not only flush the speculative bubbles away, but also instil deflationary expectations in a fashion that is very difficult to break free from - just ask Japan.


Anyway, I could go on further and explain exactly how the deflationary spiral might unfold: but I'll leave that for another post.

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In reply to: Thumper on Friday 22/04/05 11:32am

Hi Thumper,


Interesting .... will have to think about this one.

Yep US needs to change its ways. Changes in US tax laws have the govt facing worse and worse govt numbers as time goes on.


Trade balance for the US ... and US a worry.

It aint going to get better with oil imports set to rise as US domestic oil runs out.

Debt .. the same ... AUS not looking there but the number for AUS went up 14.8% last year alone ... another 12% this year .......


deflation ..... maybe ... longer term. Short term I see stagflation myself for the US.

Will keep raising rates to counter the inflation and boom ... one day all the US numbers will look like poo ..... thats next 2 years or so ... but beyond that yep maybe deflation.


For Australia .... we will not follow the US rise ... if we do ... we get there first ...

expect lower AUD/USD ... maybe the RBA has to follow the US but our market especially domestic borrowing for houses could casue a rout of the banks if we say raised rates by more than 1% from here ....


All fun and games.


Short term expect US lower as the focus turns back around to the really awful inflation numbers they just had. Dow may still try and rally some more but view it like a chiken without its head at present. Fed is going to raise in May and with this last set I am 80% convinced it will be by 0.5% which I suspect will stop the rally dead when the chicken works out its head was just chopped off.


Rising rates and oil sitting up 20% from last year ... only means increased price pressure short term.


Longer term maybe the ugly deflation word ...... not a fan of where in reality our economies both AUS and US are going. At least our federal budget is in surplus .... but our trade numbers and debt make the US look like a picnic .....


Gotta think some more on deflation .....

Myself .... I see a real risk of house prices sliding further either way.

US raises rates ... we follow ....

US economy hits a brick wall stops ... ours will slow ....

US tries and repairs the damage as you suggest and start saving ... same thing ... economy slows ......


Eeeek ... need a drink .....





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  • 3 weeks later...

May 11, 2005


Technical Analysis: Stocks Hang On

By Paul Shread



The S&P and Dow (first two charts below) held some very important support levels today, bouncing at their recent downtrend lines. But now we need to see some follow-through buying or stocks will remain vulnerable. 1164 is first support on the S&P, a level we'd like to see hold at this point, and 1158 is critical. Resistance is 1175-1180. The Dow has support at 10,250-10,263, and 10,180 is critical. Resistance is 10,350-10,405. The Nasdaq (third chart) pushed a little deeper into its old downtrend line than we'd prefer to see. Support is 1944-1950, and resistance is 1174-1180, 1185, 1193 and 2005.








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I posted this at another site earlier this week

Thought some people might like to see it here too


The Truth about CPI

An Inflation Debate Brews Over Intangibles at the Mall;

Critics Say U.S. Plays Down CPI Through Adjustments For Quality, Not Just Price; Value of a TV's Flat Screen


WASHINGTON -- To most people, when the price of a 27-inch television

set remains $329.99 from one month to the next, the price hasn't



But not to Tim LaFleur. He's a commodity specialist for televisions

at the Bureau of Labor Statistics, the government agency that

assembles the Consumer Price Index. In this case, which landed on his

desk last December, he decided the newer set had important

improvements, including a better screen. After running the changes

through a complex government computer model, he determined that the

improvement in the screen was valued at more than $135. Factoring

that in, he concluded the price of the TV had actually fallen 29



Mr. LaFleur was applying the principles of hedonics, an arcane

statistical technique that's become a flashpoint in a debate over how

the U.S. government measures inflation.


Hedonics is essentially a way of accounting for the changing quality

of products when calculating price movements. That's vital in the

dynamic U.S. economy, marked by rapid technological advances. Without

hedonics, the effect of consumers getting more for their money

wouldn't get fully reflected in inflation numbers.


But even as the Federal Reserve raises interest rates amid a recent

uptick in inflation, many critics complain the hedonic method is

distorting the picture of what's going on in the economy. They say

hedonics is too subjective and fear it helps keep inflation figures

artificially low -- meaning the Fed may already be lagging in its

inflation-fighting mission.


It's critically important for consumers, business, the governmen,t

and the economy as a whole that the CPI is as accurate as possible.

The CPI is used to benchmark how much is paid to Social Security

recipients, who last year received outlays of $487 billion. It also

plays a role in adjusting lease payments, wages in union contracts,

food-stamp benefits, alimony and tax brackets.


Getting the CPI right is immensely complex and can seem

counterintuitive. Consumers sometimes have the impression that the

government must be missing something -- since inflation has remained

remarkably low in recent years, even as housing prices, medical

bills, and other daily costs have soared. Hedonics helps explain part

of the difference.


There are also differences in the mix of things people buy. For

instance, healthy people spend far less on health care, an area that

has seen particularly strong inflation. And not everyone pays college

tuition, another area where prices have been marching rapidly higher.


The issue is likely to gain more attention now as signs of

inflationary pressures grow. Consumer prices jumped 0.6% last month,

the biggest increase in five months, as the prices of energy,

clothing and airline fares all rose sharply. On an annual basis,

consumer prices rose at a 4.3% rate in the first three months of this

year, compared with 3.3% for all of last year.


Bill Gross, head of the world's largest bond fund, Pimco, caused a

stir last fall by proclaiming that the way the CPI is calculated

amounts to a "con job" by the government aimed at concealing the true

rate of inflation. A key culprit, he said, was the CPI's growing

reliance on hedonics. Mr. Gross, who has other complaints about how

inflation is tracked, estimates the CPI really is one percentage

point higher than official figures suggest.


That's important for bond investors, who view inflation as their

biggest enemy. Bond holders receive a fixed interest payment on their

bonds that is eaten away by inflation. If there is hidden inflation

in the economy, bonds are less valuable.


Likewise, Andrew Harless, vice president of econometric analysis at

Atlantic Asset Management in Stamford, Conn., takes issue with

hedonics. "Price decline and quality improvement are not the same

thing," he says. As a result, any index that treats it as such is

likely to be misleading.


Inflation watchers at the statistics bureau say critics exaggerate

the significance of hedonics, noting that it's used in only seven out

of 211 product categories in the CPI. In most of those, officials

say, hedonics actually magnifies price increases rather than

suppressing them.


Take housing, which makes up about 30% of the CPI. Critics often

blast the CPI for using a measure based on what it costs to rent

homes rather than what it costs to buy them -- thereby avoiding the

recent run-up in housing prices. The bureau says it is more concerned

with monthly costs of housing than the long-term value of houses, so

it thinks rents are a better gauge.


The bureau says hedonics actually helps boost the housing component

of CPI. In order to take into account the aging of housing, and

presumably falling quality that goes with it, the CPI applies a form

of hedonics that links the age of a housing unit to rents. If someone

is paying the equivalent of $500 a month in rent for several years,

the rent has actually gone up as the unit ages and becomes less

desirable, according to the government.


Hedonics, which literally means the "doctrine of pleasure," was a

term first adopted by a General Motors economist, Andrew Court, who

studied auto prices in the 1930s. He had created a method of linking

car prices over time to features such as weight and horsepower, and

wanted a name for the statistical method that emphasized the link

between features and consumer utility.


The technique stirred few passions until the technology boom of the

1990s. By then, government agencies had realized they needed a better

way to track quality changes in computers and other fast-changing

high-tech goods.


Federal Reserve Chairman Alan Greenspan, testifying before the Senate

Finance Committee in 1995, said that he thought the CPI was biased

upward by as much as 1.5 percentage points. The political response

was immediate: If inflation was lower than supposed, it would be

possible to rein in deficits without cutting spending or raising

taxes. That's because the lower inflation rate would translate into

smaller payments to Social Security recipients and other big-ticket

items for the government.


Shortly thereafter Congress established the Advisory Commission to

Study the Consumer Price Index, better known as the Boskin

Commission. The panel confirmed Mr. Greenspan's view and said about

half the bias was due to product innovations, such as those seen in

computers, which were being overlooked in the CPI. Thus began a push

to apply hedonic techniques more broadly.


Today, the hub of this effort is a warren of beige-walled cubicles at

the Bureau of Labor Statistics a few blocks from the Capitol. Here 40

commodity specialists hunch over reports with 85,000 price quotes

that flow in from around the country every month. The numbers are

gathered by 400 part-time data collectors. They visit stores and note

prices on the items that make up the basket of goods in the CPI,

ranging from ladies' shoes to skim milk to microwave ovens.


One of the biggest challenges in this process is finding substitutes

for products that disappear from store shelves or change so much that

they are hard to recognize from one month to the next. With TVs, for

instance, data collectors find the models they priced the previous

month missing about 19% of the time over the course of a year.


When that happens, the data gatherer goes through a four-page

checklist of features such as screen size and the type of remote

control to find the nearest comparable model. Once this process

identifies a product that appears to be the closest match, the data

gatherer notes its price. The commodity specialists back in

Washington check over these choices and decide whether to accept them.


Mr. Harless at Atlantic Asset Management says all these judgment

calls add up to a process that is far too subjective. The CPI "takes

something you can't really measure and applies a metric to it in ways

that are arbitrary," he says. "There ought to be some kind of warning

label on inflation numbers that are derived from hedonic pricing."


David Johnson, the economist who heads the CPI program at the bureau,

says, "There's no doubt the analyst has to make decisions about

what's comparable and what's not, and where adjustments should be

made, but we try to use the data from all the markets to make that



Many price adjustments in the CPI are straightforward: When candy

bars get smaller, but are sold for the same price, the CPI reflects

that as a price increase.


Todd Reese, the commodity specialist for autos, says he doesn't need

hedonics to extrapolate the value of quality changes, because auto

makers present him with a list of changes to the car and the

corresponding prices. Still, Mr. Reese must make some tough calls as

he does his job. For instance, he recently considered a 2005 model in

which the sticker price went from $17,890 to $18,490. The

manufacturer cited an extra cost of $230 to make antilock brakes

standard, while it said it saved $5 by dropping the cassette portion

of the CD player.


The bureau accepted both those items, so the ostensible price

increase shrank by $225.


But the car maker also told Mr. Reese it wanted to subtract $30 from

the price increase for the cost of putting audio controls on the

steering wheel, allowing drivers to change channels without reaching

for the radio dial. "We didn't allow that claim," says Mr. Reese. "We

didn't judge that to be a functional change."


The most visible and controversial application of hedonics in the CPI

has been in computers, where hedonics sharply accelerated price

declines starting in the late 1990s. Recently, the bureau has quietly

stopped using hedonics in computers.


Mr. Johnson, the CPI economist, says the change, which took effect in

September 2003, was mainly driven by "timeliness" issues. With

computers changing so rapidly, the agency found it difficult to keep

its hedonic models up-to-date. At the same time, he says, the

components of home computers have increasingly become commodities,

making it far easier to price the various parts separately, such as

memory or screen size, by going straight to manufacturer sources that

list those prices.


The decision to stop using hedonics on computers in the CPI, which

hasn't been publicized, came in the wake of a 2002 report by the

National Science Foundation's Committee on National Statistics. The

report concluded that hedonics may be one of the most promising ways

of dealing with quality changes, but the agency should be more

cautious in adopting it.


"The controversy is really about a small category of electronic

goods," says the CPI's Mr. Johnson. Rapid quality advances in

everything from DVD players to microwave ovens means that hedonics

does, in fact, have the effect of pushing down that part of the

index, he says. However, electronics accounts for less than 1% of the

overall index.


Meanwhile, the statistics bureau is continuing to look for new ways

to apply hedonics. As part of its research, the agency recently

selected 10 random items, including laundry detergent, to study as

potential new areas to apply hedonics.


Ron Blackwell, chief economist for the AFL-CIO, says he is concerned

about how hedonics is used. For one thing, the method seems overly

focused on capturing quality improvements, he says.


"It's very careful on the adjustments of quality upwards, but not as

careful on judging the deterioration of quality, so it's biased,"

says Mr. Blackwell. Because of this inconsistency, he says, when the

CPI is used to calculate Social Security payments or set wages in

labor contracts, "it really understates the increase in prices that's

taken place and that's experienced by workers and retirees."


Jack Triplett, a visiting fellow at the Brookings Institution who has

written extensively on hedonics, says he often encounters resistance

from people who insist official inflation figures can't be capturing

the real picture, because the government data contrast with their own

experience. Some have suggested the CPI should be broken into

subcategories, such as one for the elderly, which would put greater

weight on items they buy in relatively greater amounts, such as

health care.


In February, Mr. LaFleur received a report about a 57-inch television

in which the price dropped from $2,238.99 to $1,909.97. Going over

the checklist, the data gatherer in the field discovered the old

version had a built-in high-definition tuner. The new one did not.

Running this through the hedonic model, Mr. LaFleur found that the

tuner was valued at $513.69. This turned what appeared to be a 14.7%

price decrease into a 10.7% increase.


In hedonic calculations, the price difference is always added or

subtracted from the previous month's figure in order to calculate the

ultimate change.


Similarly, in the case of the 27-inch television where the price

appeared to stay the same, Mr. LaFleur says it was obvious to him

that the price had declined. The latest model had a flat screen, he

says, something which consumers value more than the curved screen in

the old model. The newer TV also had a 10-watt stereo, compared with

the weaker six-watt stereo in the older model.

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In reply to: bvbfan on Thursday 12/05/05 11:53pm

Ford America knows all about inflation, they have just had to buy back a parts supplier who is having to pay $38 an hour for workers who are unionised. The supplier doesn't want to be in that business at that price. Ford is in big trouble as are many other US manufacturers.

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Several Indicators Point to Brisk Economic Growth



Published: July 28, 2005


Sales of new homes and orders for durable goods rose faster than expected last month, the government reported yesterday, providing more indications that the economy is expanding at a brisk pace.


Orders for durable goods, products that are expected to last for three years or more, like these lawn tractors outside a Lowe's store in Milwaukie, Ore., were up 1.4 percent in June.

Separately, the Federal Reserve said that the economic expansion had picked up steam and that inflation remained at bay in June and early July.


The central bank's beige book, a periodic survey on economic conditions, noted broad strength in housing, manufacturing, tourism, consumer spending and banking.


New-home sales rose by 4 percent, to an annualized rate of 1.37 million in June, breaking a record set the month before, according to the Commerce Department. The latest figures come after a report earlier in the week that showed sales of existing homes also hit a record in June.


Economists were expecting 1.3 million new homes to be sold in June.


Another report released yesterday indicated that home sales would probably continue at the current pace but were unlikely to set records. An index that gauges mortgage applications for home purchases and refinancings fell 5.8 percent for the week ending last Friday, according to the Mortgage Bankers Association. Most of the decline was in refinancings.


"The housing numbers are not surprising with mortgage rates as low as they are," said Anthony Chan, senior economist at JPMorgan Asset Management. "But low interest rates won't last forever."


Mortgage rates, which for many Americans are the biggest factor in home purchase decisions, have inched up a little in recent weeks but remain at historic lows.


The 30-year fixed mortgage rate averaged 5.73 percent last week, down from 5.98 percent this time last year but up from 5.66 percent earlier this month, according to Freddie Mac.


According to the Federal Reserve's survey, home sales remain strong nationally, but price and sales growth eased a bit in June and early July in some of the hottest markets, including New York, Washington, Florida and California.


The scene on the nation's factory floors was also vibrant. The Commerce Department reported yesterday that orders for durable goods, products expected to last three or more years, were up 1.4 percent in June after posting a 6.4 percent gain in May.


The increase beat economists' expectations of a 1 percent decline and came in spite of falling orders for aircraft and other transportation equipment, which make up a sizable and volatile part of the data. Excluding transportation, orders increased 2.6 percent.


Economists were particularly heartened to see a 3.8 percent increase in orders for big-ticket capital goods excluding transportation and military equipment. That means businesses are gaining enough confidence in the economic expansion to purchase equipment. Orders for computers and electronic equipment climbed 8.6 percent in June after a 1.5 percent gain in May.


"Businesses are going to start ramping up investment spending a little stronger than they did in the first quarter," said David Huether, chief economist at the National Association of Manufacturers in Washington.


The Federal Reserve described manufacturing as "generally upbeat," but it said job growth in the sector was still sluggish. In spite of rising prices for energy and building materials, the Federal Reserve said consumer and wholesale prices either fell slightly or remained unchanged across most of the country.


Some of the growth in manufacturing appears tied to the housing boom. The Federal Reserve noted strong growth for producers of cement and other construction materials. Mr. Chan of JPMorgan said the increased durable goods orders might be tied partly to home buying. "We want to buy new electronics for those new houses," he said.


On Friday, the government will release its first estimate of the nation's gross domestic product in the second quarter. Economists on average expect the G.D.P. to rise at a 3.5 percent annual rate after a 3.8 percent increase in the first quarter.


Cheers !!






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Have just been digging through the Australian Bureau of Statistics Numbers as I do every so often to get a reading on where we head over the coming 6-12 months.


Last time I looked I was concerned about a possible downturn in some commodity prices and the possible effect it could have on our currency for a short term period between 2006 and 2007. Specifically the boom in iron ore prices and coking coal verses a spike in the oil price. Well now 8 months later we have seen the spike in oil prices even further than I expected at this stage but things still look rosy for iron ore exports and coking coal. At the time I was worried with Australia now having to import over 35% of its oil needs due to production falling from being balanced in 2000 where we produced as much oil as we consumed to the current hole in our balance of payments of $11.22 billion per annum. At the time the level of our net balance of payments problem was bad and I suspected if things went up with oil and down with iron ore and coking coal it could possibly bring on a currency crisis. This short term gap has been totally dodged with very strong prices still across the board.


In fact the terms of trade have yet to hit the bottom line numbers in terms of current account which for the last quarter were 12.9 billion and running at record levels of GDP at roughly 6.17% of GDP. This added with the net foreign debt again at an astounding level and having seen massive growth in the last 2 years now sits at $ 430 billion a staggering 51.3% of GDP. On the other hand with the commodities boom our terms of trade measured by the ABS have seen the greatest rise on record in the last 2 years climbing from 90 to currently running at 117. It has to be said without the current commodity boom Australia and its currency would be in a hell of state.


Looking forward now Australia is enjoying the current export boom but it is the expansion of production in various raw materials which will mean our terms of trade will steadily improve over time and unbelievably I suspect even go positive somewhere post 2010 !!


The current deficit is running at $51- billion per annum. Right now massive expansion in production capacity is going on and is planned for so many industries they virtually cover every commodity you can think of. The capital expenditure and outlay to fund this expansion is hitting the current account for about 8 billion per annum. The largest single factor not mentioned often by politicians is the energy import number. This year the oil butchers bill will top $11.2 billion dollars for 2005. Alone this represents 20% of the whole problem. Our domestic oil production numbers as such will not ever get better, we have run out of oil. On the other hand we have massive natural gas reserves and in effect we will be exporting natural gas and importing crude oil to satisfy domestic demand. The net energy deficit will totally disappear with LNG expansions planned out till 2015. In fact Australia should become a net exporter of energy again despite domestic oil production falling to virtually zero by 2015. Domestic consumption sits around 340 mmboe per annum , but expansions and new LNG export projects will more than account for this by then. Recently announced NWS doubling of production and Pluto, Gorgan and Browse/Brecnock reef deposits almost totally account for this number themselves. The smallest planned for 2010 startup Pluto by WPL is going to export around 7 million tones of LNG which equates to around 61 million barrels of oil.


Second big reasons both the trade deficit and even foreign debt will not be a problem if things remain the same is the expansion in other mining industries. Coal exports both coking and thermal are set to explode with massive expansions in production and export coming on line in the next few years. Virtually every producer has announced increases of 70-150% in planned export. This alone will add roughly 10 billion to exports. Same for iron ore, again similar sorts of numbers. Breaking of the drought and improvement in rural exports add another 7 billion. Well the total so far is 10 for oil plus 10 coal 10 iron ore 7 rural = 37 bill. Then we go to some others which will undoubtedly occur, Uranium for one BHP and Olympic dam ... The plan is to double if not triple production. Either 3 or 6 billion from the worlds largest Uranium mine alone. The add copper which in reality is the main product of Olympic dam plus silver and gold and either its 6 or 12 billion ... And hey presto we don't have a current account deficit. Of course one has to add massive increases with other copper producers along with the boom currently in Gold prices .......


One traditional factor for raising interest rates if not two, the foreign debt and balance of payments deficit have been removed to a large extent from the equation. It cannot be stressed strongly enough this is heavily dependent on the current boom in resources and if that should change on the face of it our foreign accounts are in an awful state.

That being said, our currency and interest rates will both have if anything positive outlooks should the current price equation stay this way. Our currency over time should ... God forbid actually appreciate and since this will erode our terms of trade for exporters if anything the pressure on rates should be lower as opposed to higher.


So we have removed two normal factors for interest rate increases ... But that's where the fun stops. The others are employment/unemployment, CPI and inflation, GDP and house prices.


At present Australia has very tight employment markets enjoying low unemployment not seen for 25 years and the market given what is going on looks to remain about the same. It is a concern to the RBA and government but I doubt personally they will act on this alone.

GDP after going through a rocky period bounced back last quarter and looks set to be very healthy going forward if not possibly too healthy. Company profits at record levels along with the stock market the same. Personally I see substantial upside as we go forward and the possibility of this becoming a factor in 2006.


House prices, after the last raising of rates the housing sector took a massive hit especially in the super overheated markets of Sydney but despite Sydney being off there are some worrying signs the market is still far too strong in other capital cites. Again I don't expect the RBA to act on this probably the only saving grace is the high fuel costs which are seen as similar to an official rte rise and taking some of the steam out of the demand side.

Lastly and probably most worrying is the CPI.


We can ignore and discount everything from the awful balance of payments or foreign debt or the nagging still bid housing market and the tight employment situation but with CPI I feel they have run out of room to move.


Looking at the ABS numbers I have to say it ... What rubbish. According to the ABS in the last 12 months prices rose only by 2.5% overall in the year June 2004 to June 2005. Now the numbers are so tweaked by the ABS as to be absurd when we look at reality. Some of the adjustments they use to make things look better are adjusting the price down due to differences in quality, using substitution of course with the cheaper and normally inferior product, this to me contradicts their previous rule about quality substitution. Other favorites are changes in weighting on various products and the old hash brownie seasonal adjustments, funny how they occur near elections. Oh and there is the removal of some items out of the index all together and we call them now non core items.


In reality they can make the numbers say anything but looking forward I see little if any light on the inflation front. In fact I am concerned. Now why I say rubbish about the last set of numbers is a simple observation, the transport index for the year to June went up by wait for it ... According to the ABS only 3.3% and for the March June Quarter only 0.6%. A lot of things go into it but 12 months ago petrol was 90 cents and end of June it was 109 I make this personally as one of my own personal largest buys in the transportation sector but hey ... What do I know. If you got away with the year to June 2005 with only a 5% increase in your ticket price for public transport I think you were lucky. Of course included in this is the cost of a new car and I presume as in the past prices actually went down for this so the whole index was dragged down despite higher fuel costs from this.


This is where the fun ends .... Inflation the old unheard of word in the 1990's is back to stay. Simply put a lot of goods have gone down in price both in actual terms and on an adjusted CPI basis and this has kept inflation pressures very low. Car prices between 1990 and 2005 even in actual dollars and cents have fallen. A holden commodore cost more in actual dollars in 1990 than it did in 2005. If we take into account the CPI in real terms the real price has fallen something like 50%. Same for TV's ... A basic TV costs half what it did 10 years ago. Computers some thing and with the ABS using its hush puppy of Adjusting price to quality a commodore 64 in 1990 vs a pentium 4 in 2005 I wonder whether they threw in steak knives as well to make it work. ABS is not that bad but its a good example of adjusting price to quality.


Here is where it ends. A few reasons.


Number one the opening of our markets and the China factor are all spent. In 1990 Australian industries still enjoyed some tariff protection but now its virtually zero. They were forced to compete with cheap labor producers like China and the competition was one sided. As consumers we now enjoy our Chinese made TV's at 50% the price and the CPI over the years has taken all this deflationary impact into account. Now with China two things, number one is the revaluing of their currency which in effect will make their imports dearer. The deflationary effect has and will be reversed ... No more long term lowering of the CPI as imports get cheaper and cheaper. Its over !!


Number 2, the reason for why I think our trade terms and foreign debt will get better over time. If on one hand we are getting vastly better prices for our raw commodities and China basically does the worlds manufacturing, if it costs them more even with the revaluation to buy the raw goods this will add pressure to the final product prices it charges.


Number 3, we saw this week milk prices raised by up to 8%. Government argues as it does this was too much, despite this they are up and the flow on effect goes to cheese as well. Transportation prices both for imports and domestic produced goods will go up and the flow on starts. Its like a snowball going down a hill ... For a lot of the fuel price rise up till June it was eaten by a lot of producers with narrowing of margins. But once it starts and it will over time the game is on. Who uses a lot of milk ? Bread is next .... And so on. Let alone the prices for our agricultural exports. Poor old wheat farmer one of his major costs is fuel and with a 30% rise this year perversely the price of grain commodities stayed very much the same for a long time. Farmers get squeezed they either change what they produce or squeeze back. Fresh fruit and meats are next in line after bread. Bread has no choice with milk, some sort of transport costs for fresh bread.


You get the picture.


Once they raise rates it feeds the whole thing. Employee's demand more wages which are passed on to costs. Costs more to lease machinery with higher interest rates and so on.

Myself I cannot see inflation not being a factor in 2006.


Interest rates what do they do. As you can see every traditional factor for raising rates is of a concern. Goes from Trade to GDP to Employment to CPI. I suspect CPI will be the trigger whether we like it or not but not sure whether the move is correct. As we enjoyed super low rates of inflation during the 1990's from the China factor and low energy prices, maybe now we just take it on the chin and relax the 2-3% inflation target short term for the RBA. Personally not sure what good raising rates will do. It will slow domestic demand, slow GDP growth but the external factors causing it namely the bottoming of the China factor, rising energy costs will not change. These are external factors totally out of the RBA or the governments control.


What would help somewhat would be a cooling down of global energy demand but the whole commodity boom is inter linked and on one hand if commodity prices took a hit Australia is somewhat exposed with our own problems.


If the RBA in its wisdom decided to try and slow things down, the reality of raising rates in a country with 20.281 million population on say the price of oil and the inflationary flow down of that would be ... Somewhat a joke. Since we only consume 0.4% of oil production even if they caused a depression its somewhat pointless. Conversely any raise in rates adds strength one would think to our currency which even without this has seen terms of trade jump 20% in 2 years and all by itself the next problem is not going to be keeping the A$ up but down especially post 2009 the expansion of commodity exports then is mind-blowing. Possibly they do both and let the currency run to the topside, lowers import costs, lowers effective price of oil.


All in all ... I suspect with a much better GDP number coming up along with very tight employment numbers and increasing inflation numbers the ability to resist raising rates in 2006 will be one the RBA will not be able to ignore. Also the virtual bi monthly raising or rates in the US and the narrowing of the interest rate differential could also be a factor if the US keeps going.


As for our dear Kiwi friends with a trade number of 8% of GDP suggest you fellows all move to Australia and the last one out turn out the lights. No commodity boom there to save your position and just pain .....


Personally I think they should ignore inflationary impacts of energy rises and the China factor and just let our economy grow. No point in putting Australia into slowdown to try and slow say Chinese demand down, one doesn't correlate to the other. Same with energy prices unless the end goal is an adjustment this time the opposite to what we normally have our minds adjusted to.


Currency Revaluation ? What a dirty word. Risk remains higher interest rates since I am only a trader and last time I checked the RBA didn't invite me to sit on the board.


Interesting times. Of course just my own view of things and crystal ball look forward.


Views arguments comments all welcome. Lean towards raises interest in 2006 no matter what they do, old dogs like the government or RBA don't learn new tricks.



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In reply to: kahuna1 on Sunday 02/10/05 11:53am

I agree interest rates are a likely rise; if not today then in the future. It would put pressure on the housing market and again add to the oil induced squeeze upon household earnings and spendings, so probably not today.

It seems that until we acclimatize to these oil prices there will be a squeeze, either upon workers pockets or upon profit margins. Most economists have counted the direct petrol price into the inflation scenario, but few have compounded the effect as implied by fridays shock milk price increases. The investment houses dont foresee. They crunch numbers that are given them. Squeezed pockets mean more badly performing loans, which the bank backers havent factored in yet. The banks are riding on expected rises in investment arm earnings, which over the last year should prove to be substantial. With most houses saying markets are at full value, this might be as good as it gets for the banks with offshore and local competition mounting.

In the past, IT has so reduced the cost of doing business that profits emerged gratis. Now the banks have killed the goose and are running back to the community branches can they rediscover the golden eggs?.

If rates are rising, market valuations fall comparatively. And the US? We are entering a very unstable time. The australian institutions that dont recognise the dangers might fare badly?

Time will tell.


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QUOTE (auroraoz @ Wednesday 05/10/05 09:13am)

Sorry about the long original blurb.


On the trade front done some more stuff. Uranium numbers I used are wrong. But already announced expansions for Iron Ore from 200k tons to 400 k tons by 2011 export ... add 10 billion to the trade account. Same for coal ... but LNG planned expansions already announced I came up with a total of 44 m tonnes planned by 2014 ... which by itself is around the 30 billion dollar mark in exports.


We will be well into surplus if things stay anywhere near here.

A$ is going to go up and be one release valve.

interest rates the same.


Agree about banks as well. Long term ... boy not a fan. Also the property trusts are at the end of a string especailly the heavily geared ones. Same for infrastructure companies if geared to heavily. Overally large negatives on stock indexes ... on the other hand made up for by the mineral exporters ... the expansions planned for some are well over 100%.


Will be interesting times.

House prices if correct.... despite inflation I remeber the higher rate environment of the 1980's and early 1990's and frnakly you couldn't give them away.

Don't expect double digit interest rates ... it won't take that much to crush the living hell out of everything .... but cash from 5.5% to 8% will shake the tree. Lower P/E's demanded for investments as they compete with interest rate deposits. Lower NPV values due to higher NPV interest rates used.


Should be fun

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