Debt, Food and Energy

In what’s become an unusual event, the S&P500 actally sold off, giving up 1.7% on the week.  Tellingly, volume jumped in this period, as opposed to falling when stocks rise in price.  This is lends more credibility to the sell off, meaning that there’s more conviction among investors and traders when stocks fall rather than when they rise.  Volatility also spiked.

The macro data were mixed.  Housing is definitely double-dipping as confirmed by Case-Shiller which reported another month of price drops for single family homes across the country.  While consumer sentiment and confidence rose, it did so in the face of low job creation, house price deterioration and soaring gas and food prices; the uptick in confidence will likely reverse itself soon.  Existing home sales were slightly better than the miserably low forecast set by the experts; new home sales was even worse than the grim expectations.  Durable goods orders disappointed badly, especially when government-driven military and aircraft orders were removed.  Initial jobless claims were slightly better than expected, but a whole slew of states estimated their figures due to the holiday shortened week.  Finally, 4th quarter 2010 GDP missed expectations, which had risen from 3.2% to 3.4%.  Instead, GDP growth fell to 2.8%, which is an amazingly poor figure given that we’re in the middle of a so-called recovery.

Technically, the uptrend in the S&P, when examined on the weekly charts, is still in effect.  The S&P would have to close and remain well below 1,300 for this uptrend to break.  On the daily charts, traders can look to potential shorting opportunities next week.  If the S&P fails to return to its recent highs, then there will be a fairly high probability that the index will fall further.  Adding to this probability are all the long-term bearish divergences that have been building over the last four months.

Almost all of the economic and financial forecasting that affects the markets revolves uses, as a starting point, the fiscal and monetary policies of the US and the rest of the world.  Deficit spending by the US, for example, is a form of stimulus that helps promote GDP growth and stability.  Monetary policy, lately, has dominated the news because of its extremely stimulative measures, namely quantitative easing, and they way in which they have clearly propped up financial asset prices over the last two years.

So naturally, when analysts look to risks and other factors that could derail the financial markets, most search changes in these two hugely important policy measures.

But what many analysts take for granted are several foundational assumptions that may have an even greater impact on the economy and financial markets:  food and energy.

And what’s key is not simply the availability of food and energy, but the availability of CHEAP food and energy.

Why?

Because a large amount of the world’s economic growth over the last 30 years can be explained by the existence of cheap food and energy, specifically oil.

As much as the massive ballooning of debt has pushed GDP growth, the availability of cheap food and oil have been equally important pillars of this growth.

But the problem is that–unlike the growth of debt, a financial instrument–cheap food and cheap oil may not be as easily managed by the leading governments of the world.

While the US central bank can print dollars, it cannot print food and oil.

And over the last few weeks, we have seen just a bit of the consequences when the assumptions of cheap food and oil do not hold.  As Tunisia, Egypt, Libya, Bahrain and probably others soon are transforming themselves politically, the price of oil has skyrocketed.  As the world’s population grows (demand rises) and climate changes repeatedly destroy production through heat, fire and flooding (supply falls), the price of basic food grains has soared.

Both developments have the potential to crush economic growth.  And both developments cannot be magically cured by more fiscal or monetary stimulus (in fact, money printing adds fuel to the rise in food and oil prices).

So the world’s leaders are in a major pickle today.  As much as they have yet to fix the financial imbalances that led to the global financial crisis and the Great Recession, they will now have to grapple with two other major headwinds:  the soaring price of food and oil.

If the odds of another future financial crisis were high already, the odds have now gotten even higher.

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