Mixed Signals

Why would that guy on eBay want to sell his ashtray from the old Las Vegas Sands hotel? I don't know, but I bought it. All markets, from eBay to Wall Street, are characterized by participants who want to sell and those who desire to buy, coming together to navigate and negotiate a bid/ask proposition to arrive at a transaction. That is always, by definition, true, but sometimes the differing perspectives of buyer and seller turn out to be downright conundrums. Sometimes the larger economic environment that informs such perspectives is so fraught with conflicting signals that it is almost impossible to discern where the true weight of the evidence lies.

The noted economist Milton Friedman emphasized that "Inflation is always and everywhere a monetary phenomenon..."--another version of this thought being that inflation is caused by too much money chasing too few goods, or money growth that outpaces output growth. Friedman died in 2006, so we can only speculate as to his thoughts about the Federal Reserve's unprecedented monetary stimulus over the past several years. I imagine he would have endorsed it only as a laboratory experiment.So far the results of that experiment have not yielded the expected inflationary outcome, as inflation remains quite low even with all the money sloshing around to chase prices higher.

The yield on the 30-year U.S. Treasury Bond now hovers around record low levels just shy of 2.4%. When the federal government borrows money to finance budget deficits, its activity in the credit markets is said, according to economic theory, to "crowd out" some private borrowing as upward pressure is put on interest rates. That's one reason to raise an eyebrow at the bond market, as interest rates have fallen even as the government continues to borrow. The other eyebrow might go up because record-low long-term interest rates are not what we would expect to see when the economy is expanding.

One explanation for these seeming contradictions is the increasingly global nature of the economy and capital markets. Our government's borrowing doesn't cause interest rates to skyrocket because other governments are more than willing to buy our Treasury bonds. Inflation doesn't tick up because there are plenty of places around the globe where the costs of labor and manufacturing are cheap. And these realities were in place before the price of oil went through the floor. Add to that the fact that yields are even lower around the world, and that the main concern is becoming deflation, not inflation. When central banks used to talk about hitting inflation targets, that usually meant managing monetary policy to bring inflation down--now they are targeting higher inflation, concerned that economies might slip into the deflationary pit.

When Wall Street opened on Tuesday, it appeared that the blizzard that hit New York City had kept all the buyers stranded at home while the sellers had no trouble making their way to Lower Manhattan. The real culprit, though, was an unexpected reported decline in Durable Goods orders, which were expected to be up slightly in December but were actually down 3.4%. Then Caterpillar (CAT, $79.85) chimed in with disappointing earnings and weak outlook, citing its exposure to the energy sector. The strength in the U.S. Dollar is also doing its part to inflict some pain on the multinationals. This serves as a reminder that the energy boom in the U.S. has been a strong driver of economic growth and a source of strength for companies in the manufacturing/industrial sector--and that the downturn will not be limited to those companies strictly classified as belonging to the energy sector.

So, with the Dow Jones Industrial Average down almost 400 points Tuesday morning, was there anything that wasn't collapsing? The shares of Ulta Salon, Cosmetics, and Fragrance (ULTA, $135.84) were managing to eke out a fractional gain amid all the selling in the morning before closing the day down 24 cents. ULTA is a retailer of, as the name suggests, a variety of beauty products across a range of price points--and a company with no international exposure. Did ULTA escape the selling because people in the oil business don't care about looking good and smelling good? I can't speak to that, but what I can say is that ULTA is a growth stock, and its stores offer salon services in addition to the beauty products it sells. It is sort of a luxury spa for the masses--and by that I mean the mass market. The business model is familiar, as Starbucks (SBUX, $88.34) has found success in bringing gourmet coffee to the mass market, and Nike (NKE, $94.50) and Under Armour (UA, $71.96) have grown by bringing performance athletic wear to the masses. This might just be a place where consumers decide to spend the extra cash in their pockets that they saved at the gas pump. Never heard of ULTA? Consider that a plus, or at least an indicator that it has not yet saturated the market.

Analysts like to describe the current U.S. economy as being "the best house in a rotten neighborhood." One has to wonder, though, how long this can last before the world's economic weakness spills onto our shores. Deflation is the scourge of economies and markets, and we should be watching for signs that might indicate whether our own Federal Reserve is starting to worry about contagion. If the Fed ends up NOT raising interest rates this year, that stance could actually be the proverbial canary in the coal mine.

Life is short. Get busy.

Jim

Disclosure/Disclaimer: My family members and/or I own shares of ULTA, SBUX, NKE, and UA. Individual stocks are mentioned here for the sole purpose of illustrating investment concepts, and nothing stated here should be construed as the advice to buy or sell any security. Stock prices are as of the close of regular trading on January 27th, 2015.