Which Way the Wind Blows
by Sinclair Noe
DOW – 30 = 15,963
SPX – 0.49 = 1819
NAS + 10 = 4201
10 YR YLD + .04 = 2.76%
OIL + .33 = 100.27
GOLD + .90 = 1292.80
SILV unch = 20.34
SPX – 0.49 = 1819
NAS + 10 = 4201
10 YR YLD + .04 = 2.76%
OIL + .33 = 100.27
GOLD + .90 = 1292.80
SILV unch = 20.34
After a four day rally, the stock market came back to a
dose of reality.
Just a reminder that the Fed has started gradually
reducing the amount of money it pumps into the economy. The move could hardly
have been a surprise, because the Fed announced as early as last spring that it
would begin doing so by the end of 2013. Now, it’s happening, and likely won’t
change, and Janet Yellen said the rest of the world needs to adjust because the
Fed has set its course. That has made for shaky markets around the world.
Remember that about a month ago, we started worrying
about emerging markets. China said their economy was slowing down; that in turn
will hurt the exports of commodity producers, weakening their trade balances. The
big question now is how much further growth in China will slow. A serious
cutback in China’s demand would not just harm emerging markets’ shipments
directly to China, it would also cause further erosion in the already falling
world prices for emerging markets’ coal, copper, palm oil and other
commodities. China is also dealing with a shadow banking system ripe with
potential defaults. But that isn’t the only problem in the world.
Many of those emerging markets also have unique economic
and political problems that seemed to boil over at about the same time. So, the hot money has been exiting emerging
markets. This is the same hot money that flooded into emerging markets when the
Fed had the printing press cranked up to QE3. This has happened before. It
happens all the time. Back in the late 90’s the Asian economies vowed to avoid
a repeat by building up trade surpluses and saving with a vengeance. They held
back on investment and consumption; they hoarded foreign reserves, such as US
Treasury bonds, which in turn lead to a speculative bubble in American subprime
mortgages. Just to remind us all that we are not alone in this global economy.
The Federal Reserve says recent efforts by emerging
markets such as Brazil, India and Turkey to stem investor flight from their
economies are just “stopgap measures” that need to be followed by heftier
policy actions. The Fed issued a report saying continued progress implementing
monetary, fiscal and structural reforms will be needed in some emerging market
economies to help remedy fundamental vulnerabilities, put them on a firmer
footing, and make them more resilient to a range of economic shocks.
The Fed said in its report that many emerging markets
learned from the financial crises in Asia and Latin America in the late 1990s
and early 2000s and moved to flexible currencies, building cash reserves and
cutting their dependence on foreign lending. Now, the response in the emerging
markets seems to be slamming on the brakes by raising interest rates as they
emerge, potentially sacrificing investment and jobs along the way. This is
probably an imperfect reaction. I don’t know what was learned from the crises
of the past, but those problems haven’t disappeared with a four day rally on
Wall Street.
The Fed’s comments are likely to fuel debate at the
upcoming meeting of finance officials and central bankers from the world’s 20
largest economies late next week in Sydney, Australia. The whole mess might
even result in strategic shift from China to other developing Asian countries as
the preferred locale for making export goods. And if the developing countries
don’t step up, it raises the question of whether the EU or the US could fill
the void.
I ran across an interesting
article from Vanguard. It says financial data is notoriously easy to
manipulate. You probably knew that, but the article says a difference of only
one year can have a major effect on the five-year annual performance returns of
U.S. stocks. If your starting point is 2013, this number is an impressive
18.7%, because it omits the big drop in 2008. But if you ran the numbers just
one year earlier, from December 31, 2012, the five-year average return number
dropped to 2.04%. Vanguard correctly concluded that basing investment decisions
on "data-dependent snapshots" could be a big mistake.
Let’s talk about the weather. Not the Ice storm in the Southeast;
you know about that; hundreds of thousands of people without electricity
because the ice on the lines or on trees that fall into the lines; more than
3,000 canceled flights. Atlanta looks like some frozen wasteland in an
apocalyptic science fiction movie. Soon, the storm will pass and meander up the
seaboard and dump a foot or so of snow on New York City. Yesterday, Fed Chair
Janet Yellen said the wild winter storms probably had an impact on the December
and January jobs reports; probably knocked a smidge off the GDP as well. It’s
important, but that’s not the weather I want to talk about today.
Today, I’d like to talk about the drought in California.
Of course, last week a weather pattern known as the pineapple express dropped
some rain on the state, and all it seems to take is one decent rainstorm to
wash away all awareness of a drought. But it would take three months of nearly
solid rain to get out of the current drought and that isn’t going to happen.
Here’s what will happen.
Food and electricity and water will all cost more. And
then there will be additional costs to build up water systems because if we don’t
then things will get really dicey. The scientists have been warning us for
decades that droughts will become more common. Predicting any single season’s
rainfall is tough but forecasters think this year may be the driest year in the
last 500 years. Most of the state is experiencing “extreme drought”. About 10
percent of the state is experiencing "exceptional drought," the
highest possible level. Several smaller communities are in danger of running
out of water, soon and despite the rain last week.
Most of the computer modeling seems to predict that over
the next 3 to 5 decades, the changing current patterns caused by melting sea
ice will increase average annual precipitation in the Northwest by about 40%,
and average precipitation in the Southwest will decrease by 30%, maybe faster. Those
are big changes, but before we get there, we’ll get smaller previews of the
future.
Let’s start with agriculture. California produces a good
chunk of the nation's food: half of all our fruits and vegetables, along with a
significant amount of dairy and wine. Many farmers who plant annual crops have
already made plans to cut back on planting to conserve water.
Farmers who tend crops that grow on trees and vines are
in a tougher position, because their plants have to be maintained year-round.
The good news is that it usually takes more than one year of drought to kill a
tree, the bad news is that one year of drought can wreak havoc with production,
and the worse news is that we’re in the third year of drought. An almond tree after one year of drought will
lose 50% of production, and even if we get normal water levels next year, the
production will continue to drop by 90% before returning to normal. So, this
year will be bad and next year will be worse. The most vulnerable crops are
probably stone fruits like plums, cherries, peaches, and apricots, which are
adapted to wetter climates.
For California rancher’s the drought means less grass for
beef and dairy cows to graze, and that means many ranchers are selling now. If
you enjoy a barbecue, enjoy it now before you have to take out a loan for a
steak.
Expect shortages and possible price increases for lettuce,
broccoli, melons, citrus, and rice. Yes California is a major rice producer. Of
course, rice is an international food stuff, but in China there has been a
major drought as well. Citrus also comes from different parts of the world, but
remember the southeast has had a crazy cold winter that has already caused
damage to citrus crops.
Expect to spend more on electricity. Hydroelectric energy
makes up about 14 percent of the state's power supply. With less water running
through turbines, the grid may need to use more natural gas, which is more
expensive. And the state is also running low on natural gas, in part because of
the extra demand generated by Eastern states. Southern California has become
increasingly dependent on natural gas-fired plants since the decision last year
to shutter the troubled San Onofre nuclear power plant. When it was operating,
the twin-reactor San Onofre plant produced enough power for 1.4 million homes.
And there will be extra costs to clean up the San Onofre site, which will be
passed on to you. And just last week there was a “flex-alert”, where state
officials called for people to turn off the lights and anything else that was
sucking power. A flex alert in the winter is strange indeed.
And don’t forget the fires. In Southern California, fire
season really never ended. Seasonal firefighters in Southern California,
usually employed only during summer and fall months, have stayed on staff all
year long. And already this year, this winter, wildfires have been igniting all
up and down the state. Cal Fire is considering expanding inspections to check
compliance with "defensible space" rules, which require that
residents have 100 feet of space free of flammable materials, like brush or
other vegetation, around their houses.
And finally, water will cost more. Conservation will be
increasingly important but it can be costly. One solution is desalination
plants, but those use lots of energy and are very expensive. Transporting water
is a possible option, again very expensive. Major water projects can’t be constructed in 2
or 3 months. Planning and infrastructure involve a lot of lead time. There
really isn’t much choice. It has to be done.
