Testy Tuesday Morning

Non-core inflation is 4.8%.

That is what is true and not spun.  Today the CPI will once again slap you in the face and investors will be asked to turn the other cheek and ignore the real number by embracing the fantasy core number that will tell you that inflation is under 2.5% and any extra money you think you are spending for things is a product of your deluded imagination.

I don't mind inflation (see "Inflation Nation"), what I mind is lying about it which causes both people and policy makers to make poor planning decisions.  The truth about our fiscal situation is just too terrible for words so we'll ignore that for now but it would be nice if the government at least tried to make an honest assessment of costs. 

While the situation may not be quite as dire as the New Media video concludes the problem with the economy is we don't have a normal curve of inflation right now.  Usually inflation is an across the board event where goods and services rise.  While this does lead to higher prices it also transfers more money to employers who ultimately have to pay their workers more as they demand "living wages" to keep up with the inflation.  What we have now is a very specific inflation that is centered on something people can't live without – energy.  Since there is no option to cut back on energy, consumers spend more on energy and less on everything else.  Since demand drops in the broader market, workers cannot get raises but food and manufacturing costs increase (as they consume energy too) and employers make less money, causing them to buy less goods and services.

Since everyone in the chain if forced to spend an ever-increasing portion of their capital on energy (something they can't do without) the rest of the economy is effectively sucked dry.  This all seems fine while the economy is good but it can lead to a vicious correction should we hit a bump in the road.  At $4 per gallon, it now costs a Californian $60 to fill up the average gas tank.  With an average commute of one hour per day, it costs the average worker $12 per day just to get to their job.  $240 per month, per driver is a pretty heavy expense.  Compared to $2 per gallon that's $120 per month that doesn't go to the Gap, the movies, local restaurants, savings (LOL, just kidding about savings, these people ARE Americans!)…

Of course there's also the cost of heating/cooling, electricity and the creeping price of food, which is now being used as energy too.  That's why we got such a nasty reaction to yesterday's Fed survey, which showed that banks were tightening lending requirements.  Without a ready supply of borrowed money – this whole house of cards could collapse any minute!

We got a another free pass this morning as the CPI came in lower than expected (.4%, down from .6% last month) but Asia sure was worried and had a big sell-off this morning and we need to stay worried too as it won't take much to tank the markets so I will continue to put in the occasional cautionary tale despite all bull markets to the contrary.

The mighty, mighty Shanghai Stock Exchange dropped 3.6% (not shown on this chart)  this morning as investors there took profits off the table following a spectacular run but the pullback in the other Asian markets was mild by comparison so we are having no repeat of the Feb 27th China Syndrome.  This by itself should give confidence to US market bulls but will it be enough to get the S&P to 1,530?

Europe was trading down early but perked up when the CPI came in lighter than expected.  Commodities remained under pressure on signs that the dollar may be bottoming out.  The $17Bn Reuters merger seems to be moving ahead and Heidelberg Cement is paying $16Bn for Hanson Building materials and Xstrata raised its offer for Lion Ore to $5Bn.  It's hard to have a bad week with people putting $38Bn into the markets!

Our markets would do well just to hold their critical levels but I still maintain we need a break in oil to get to the next leg of this rally:

We lost a position on each of the Asian markets so that's a big danger sign but, as I said, it could have been much worse with the Shanghai dropping 147 to 3,899, that would be like a 200-point drop in the Nasdaq only knocking 100 points off the Dow...

Oil needs to break well below $62.50 as we need the rollover contract to be down here next week when the front-month switches to July or we may WISH we had $4 gas in August.  I still expect at least one $2 down day this week in the oil patch but it will be tough to get ahead of tomorrow's inventory report.

Gold is holding onto $470 and the dollar is holding onto 82 and we are holding onto our calls but not for long if we break down from here.  Our plan for the day is to go with the flow as we remain well hedged but that's no reason to miss some good short opportunities on the turn.

WMT came in with a good report but HD did not so we will watch retail closely today as an early sentiment indicator.