Market Commentary for the week of June 9, 2008

Global inflation risks are strengthening, and not simply limited to the U.S. and our “pain at the pump” refrain. Indeed, as the rest of the world modernizes and integrates into industrial production, the demand for natural resources, wage increases, and a heightened standard of living will put a strain upon barriers and price points that heretofore had kept a lid on runaway excesses.

We do ourselves an injustice when the inflation discussion is limited to our shores, Western nations in general, or the English-speaking population.

Structural decomposition.

This past week the topic of global hunger and food shortages was addressed by the United Nations’ Secretary General. Right now he speaks with a voice more significant than any Central Bank representative, or Wall Street tycoon, because the issue is not solely about money greed or profit, but about equitable allocations of precious resources. Could potable water be the next black gold?

Thus far, titans of industry have steadfastly refused to acknowledge the inconsistencies of their rabid price increases, exorbitant profit margins and declining standards of living in the poorest parts of the world. Their approach is to view these “headlines” as arm’s-length events, when in fact their benign assessments are way off base. Structural price pressure has been building into global commerce since 1999 and skewing profit and industrial patterns worldwide since that time.

The difference for most observers is that inflation has been limited to highly visible and obvious sectors. But when the patterns of price increase (and profit erosion) spill over into everyday costs like food, medicine, education and transportation it has an effect upon psychology and spending patterns. What’s the old saying, “It’s a recession if it affects your neighbor; it’s a depression when it affects you.”

Like a wildfire.

The interesting thing about declining psychological exuberance is that it carries over into all facets of day-to-day life. No one likes to think that their standard of living is going down, nor do they want to be forced into either/or decisions about necessary and discretionary spending. But that’s exactly what the market (retailing) is observing. The data is understating the severity of the financial and moral crisis the economy is facing.

Among the most important macro trends my data has uncovered in the last decade is the decline of retail/consumer influence upon profits and the diminution of unit volume growth in industrial output. I was early with this message, writing about it as far back as 1998.

Dot.com, or dot.natural resources?

Looking ahead, my data is identifying a new paradigm, just not the one the dot.com generation envisioned a decade ago. Theirs was a nirvana of productivity borne out of technological innovation, a wristwatch that might control every facet of modern life. My data does, in fact, recognize the expediency of technology in medicine, communication, energy production, information processing but at what cost? If machines can produce more efficiently than humans, and more cheaply, then we could see the genesis of the demise of human production lines and capacity employment. Even Wall Street has begun the process of laying off floor traders, analysts, and portfolio managers, as machines systematize the delivery process of analysis and services.

My data is not conceived to predict future trends, simply to reflect and quantify the trends that are there. I am confident that the challenge of measuring the effect of inflation upon equity analysis and performance is in its infancy, and not yet fully developed. The key is to break through psychological rigidity to uncover new sector trends that might create capital gains opportunities where currently very few seem obvious.