What Do I Do with this Information? Financial News Edition

By Bob Iaccino, Trader Outlook

Business news television channels can confuse things for everyday investors as often as they clarify. In the interest of full disclosure, I appear on business news 2-3 times per week as a guest analyst, but I do my best to use phrases like “from a trading perspective” or “in the short-term” so as to not mislead people. I am a trader and my time horizon for trades can be short, but in the interest of clarity, I want to discuss 3 things that the news channels are focused on and explain some nuances.

Debt:  Many of the developed economies have debt problems. The US, UK, Japan, France and of course, the PIIGS (Portugal, Italy, Ireland, Greece and Spain), but not all debt is created equal. What these debt-laden countries do have in common are the choices for dealing with this debt: pay it off (not possible) or default (not popular). The important thing for traders and investors to realize is the differences in the debt: the countries listed are all in similar balance sheet position but the PIIGS cannot print their own currency. Japan, the US and the UK can. This is why rates in the PIIGS nations + France are rising rapidly yet the “J.US.UK.” countries interest rates are actually falling. They are falling because a third option for dealing with debt in the JUSUK countries is to print more money (the only politically palatable choice). The US economy is facing the triple headwinds of deficits, debt and poor demographics which will lead to probable Japan-like growth in the decade coming up…or worse. The next decade is likely to have unprecedented inflation for indebted countries that can print currency, while emerging markets and recovered PIIGS nations will show more price stability. The PIIGS are being forced to take their pain, whether austerity, default or both, while the JUSUK counties just keep printing.

Many people think inflation can only come into play during strong growth cycles where limited money is chasing too few goods, causing prices to rise. The money in this scenario comes from fast growth, which increases hiring. A worker shortage causes wages to rise and newly flush workers cause demand to rise, all contributing to a rise in prices. This is called the “wage/price spiral” and has been the most common scenario in recent history when inflation has shown itself. It is also why economist and the central banks have focused on “core” Consumer Price Index (CPI). In the past, wages have been the biggest contributor to the price of products, and wages are a heavy component of the core CPI. There is however, another type of inflation. Inflation caused by monetary expansion or “money printing.” This inflation is driven by excess monetary expansion that drives currency depreciation.  As the major currencies decline, all that new paper currency seeks assets to protect wealth – those assets are likely to be hard commodities including but not limited to precious metals and energy as well as food and, importantly, export prices will rise materially. Think of all the goods the US imports from what have been cheaper sources of labor.  A depreciating currency and higher energy prices will materially change the price of goods the US imports overseas as well as the cost of shipping those goods due to higher energy prices. You will hear analysts say that core CPI is not showing inflation, but commodity prices, especially gold, are screaming it from the rooftops.

Stagnate economic growth and wages combined with inflation is what is known as “Stagflation.” That is where the global economy is headed over the medium term. Equities in emerging economies are likely to fall initially with developed countries given export orientation but will recover much faster than debt laden, inflation plagued, developed countries and for the first time, may be the best place for longer term investors to look for “risk-adjusted” returns. In the past, they seemed riskier. That may be changing. Understanding risk is something we teach and is something you MUST learn to grow and maintain wealth.

To most people risk means “How much money am I risking?” That is too simplistic of a definition when it comes to trading and investing. Given the possible long term scenario I’ve described above, is US debt with a 2.5% yield risky? US stocks? Greek bonds? In recent history, emerging market equities have provided higher returns to long-only investors, but have also crashed harder in times of trouble. This is likely to continue, but the risk to reward ratio of emerging market investments are likely to improve dramatically simply because they will be one of the only places providing return and are not in the debt morass of the developed nations. US and Japanese bonds have always been safe havens but with default becoming a possibility, however slight, and monetary expansion forcing yields to stay low, they become very poor sources of “risk-adjusted” returns. Return stays low, risk increases.

The price action trading we teach at Trader Outlook (14-Day Trial Link Below) eliminates economic analysis from trading and puts you in control of short term, risk controlled trades. Taking speculation, not out of trading, but out of risk. In the coming years, investors must become traders and traders must understand and control risk, because we are entering a 10-20 period of market metamorphosis.

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Editor’s Note: For updated information on this and related topics, see our new website: PremierOffshore.com


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