Tuesday, March 27, 2007

Greenspan and Data

"Most economists were initially skeptical about increases in productivity. But as time went on, Alan said that the data he was pouring over didn't reconcile unless productivity was substantially higher than was generally thought. One of Alan's great strengths is his wide-ranging focus on data and his insight in drawing inferences from it. He'd show up at breakfast and ask what I thought about the latest railcar shipments of some type of wheat I had never heard of before. "Alan," I'd say, "I don't know how I missed that figure in the paper, but I did." He would have worked out a whole hypothesis around it. Greenspan was the three of us to reach the tentative conclusion that productivity growth did explain the absence of expected inflation. That meant that the speed limit on economic growth was higher than we'd thought. Larry and I followed in agreement somewhat later."

Robert E. Rubin, In An Uncertain World (2003)

This quote from Robert Rubin's book, In An Uncertain World, shows the depth of the data the Fed watches when making decisions about the economy and inflation. This view on productivity was said with the constant being that this growth was accompanied by strong sound fiscal policy. Whoops! We do still have relatively low interest rates compared to historical standards. Is that always going to be the case? Enough about economics.

This chart shows the divergence between the NYSE Composite Index and the Dow Jones Transportation Index. As the NYSE made new highs starting last fall, but transport index didn't confirm the rally. This could be because the transports are so closely correlated to the car industry and the homebuilding sector. Both of these groups were strong for so long. It started back with 0% interest rates on cars, then 0% plus cash back. The real estate market was benefited by low interest rates and the fact that it was an attractive area for investment compared to the stock market, which took such a beating starting in 2000.

The bright spot in the transportation area, are the railroads that deal in the transport of raw materials. Commodity prices are still holding strong, and could only get stronger with the dollar getting weaker. Even if demand slows here in the United States, global demand is going to remain strong for basic materials. China and India want stainless steal refrigerators and appliances like we have. They want cars and houses and all the things we have. So demand should stay strong globally. This could lead to inflation and put the Federal Reserve in a tough position with slowing growth here and raising rates to curb inflation. The market seems to be addicted to the idea of rate cuts. If the Fed cuts rates, it will be for a reason that won't feel good at the time its done. They might not want to say it, but the risk of inflation is still great. The risk is brought on by global growth.

This is a chart that shows the railroad index in comparison to the Dow Jones Transportation Index. In the lower part of the chart is the Basic Materials SPDR. In this we can see that material stocks are performing great, along with some of the railroads that carry their products. The transportation sector as a whole is not as strong, because trucking and air freight costs are so effected by the very same basic materials.

It is important to watch the transportation stocks and in particular the railroad stocks. They are the carriers of the raw materials and commodities that are in the leadership group of our current market. These stocks are high fliers, and can have 10-30% pull backs and still not break their longer term trend lines. Look for pullbacks and when everyone on TV says the bull run in these stocks is over...that is the time to buy them.

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