Investors Tell the Fed to Take a Hike

~~~Three tips to beat inflation
~~~Ethanol spells opportunity, and any storm sparks water investments…

Dear American Capitalist Reader,

“Inflation is here and it’s not going away anytime soon,” or so says the FOMC, as it gets ready to hike the Fed Funds target rate another 0.25% when the Committee meets next week. Some media “experts” and economists are even forecasting a 0.50% increase to help tame the inflation animal.

Realistically though, investors can expect a .25bps increase next week and another .25bps on August 8 to bring the target rate to 5.50%. I know this forecast is a complete about face from my prior comments, but -- oddly enough -- the economy is humming along and its enemy, inflation, is gaining steam.

Data is stronger than expected

All one needs to do is look at the data. Last week, the University of Michigan reading on consumer sentiment was reported higher than expected. Evidently, consumers continue to smile even though they’re being slammed by $3+ for a gallon of gas.

And then, the Department of Commerce released a surprisingly positive U.S. housing starts report: May housing starts increased by 5%, while the consensus expectation was for a 1% gain. Interestingly enough, the April figure even had an upward revision.

Demand is softening, however, as housing starts are still 14% below the January peak and the second quarter average is about 10% below the first quarter average. Any way you want to look at it, the housing market is simply cooling, which is a long way from collapsing.

Economy is warmer than room temperature

The economy is still growing at a rate that some would argue is warm, not hot, but it certainly isn’t room temperature. The Fed’s prior 16 rate increases have slowed down the economy, but it’s not doing too much to shut down the housing market.

And, why should it? The media likes to sell us with stories about a housing collapse, and it always makes interesting reading after the Fed hikes interest rates because higher mortgage rates typically follow, thus slowing down the housing sector.

But, guess what: homebuyers don’t care. Even if mortgage rates hit 7% this summer, as some mortgage bankers are predicting, they are still lower than the double-digit rates we witnessed in the late ‘80s and early ‘90s.

So, buyers are forced to buy a smaller house and sellers will settle for a slightly lower price. It doesn’t matter because as the data explains, a 7% mortgage isn’t going to stop people from buying what they want.

Inflation is a cancer

If I was Chairman Bernanke I would instruct all of the central bankers to worry about one thing and one thing only: Inflation. It needs to be stopped. Higher rates won’t kill the spirit of the American consumer, but inflation will. It paralyzes growth and discourages saving. It acts like a cancer -- if it’s not controlled and stopped, it will kill the economy.

President Ronald Reagan once had a fitting quote: “Inflation is as violent as a mugger, as frightening as an armed robber and as deadly as a hit man.”

Reagan would know about the problems of high inflation because when he entered office, the United States was staring at double-digit inflation and an economy stuck in quicksand. Will that happen again? Who knows? But the May inflation reading of 4.17% is only the second-highest rate Americans have seen in the past 15 years. Inflation has to be the biggest concern for the Fed right now.

Steps to help investors beat inflation

Today, investors have many challenges when it comes to maintaining a well-diversified portfolio. In addition to extreme market volatility and saving for retirement or tuition, investors have another concern to worry about: Inflation.

Inflation affects everyone. It doesn’t matter which social class you are in or how much money you have in the bank -- inflation can decimate your financial security because it erodes purchasing power and reduces what your money can buy.

So, what’s an investor to do? Well, the good news is there are opportunities available for you to guard your portfolio against inflation and we have listed three of them for your consideration:

Use Treasury Inflation Protected Securities (TIPS).
Buy stocks.
Consider alternative investments like gold.

1. TIPS

TIPS are excellent investments to help combat inflation. Your purchase is directly tied to the Consumer Price Index (CPI) -- therefore the principal investment in a TIPS increases with inflation, or will decrease with deflation. The periodic adjustment in the principal is an excellent way to earn higher interest payments as prices rise, thus, maintaining your purchasing power.

For example, a person invests $100,000 in TIPS yielding 2%. If the CPI rises 3% over the next year, the investor would still earn 2% on the investment, but now the interest would be based on a principal value of $103,000. Also, TIPS pay interest twice a year.

2. Stocks

Buying and holding onto stocks is another way to cure the inflation bug because returns on stocks have generally outpaced inflation rates. For example, the S&P 500 has gained 10.4% annually from 1926 through 2004, easily beating the average 3% inflation rate during that time. Stocks of smaller companies have performed even better, returning 12.7% annually during that same time period.

To compare, bonds have had a tougher time winning the race against inflation. In fact, intermediate-term government bonds have delivered an annualized rate of just 5.4% over the long run.

Whether you are young or old, novice or professional, everyone should have some part of their portfolio in equities to help them defeat inflation.

3. Gold

Commodities like gold typically perform well during periods of inflation while often providing equity-like returns over time. This bullish action is because the money backed by gold cannot be created arbitrarily by government action.

By removing this uncertainty in currency, gold tends to appreciate during periods of inflation and makes a terrific compliment to your inflation-fighting portfolio.

The Fed has its hands full with the inflation battle, but I hope these few suggestions will help curb any concerns you may have for your portfolio.

Sincerely yours,

Todd M. Schoenberger,
Editor, Red Zone Network

Over to Ian Cooper with more…

Trash to riches

There’s a high probability that oil prices could very well triple from their current $70 price tag if push comes to shove over Iran’s nuclear ambitions. In fact, it’s the Saudi Ambassador to the United States who’s speculating about this very scenario should the United States take military action against Iran. It’s not as if President Bush is going to give Iran until mid-August to make a decision -- instead he will give Iran weeks, not months, to signal a deal or no deal.

Should oil really skyrocket to historic highs, inflationary pressures resulting in more Fed rate hikes will take center stage and cripple our chances for remaining above 11,000 on the Dow. But where do you put your money should oil actually triple? Ethanol.

We’re currently doing our due diligence with one company that’s turning trash to riches. The secret to this company’s success is its discovery of yeast found in the intestines of a beetle that can digest just about anything. It’s this yeast that will be used to “brew ethanol,” and allow the company to convert garbage into ethanol for an average 85 cents per gallon less than every one of its competitors.

While most ethanol companies are located in a corn belt, this company can set up shop anywhere there is a waste stream. That means it can produce and sell ethanol in places where it’s never been made before eliminating additional costs in time, transportation, and fuel.

And if you think it’s a crazed idea with no future, tell that to those running the Dyess Air Force Base in Texas that has plans to use 42,000 tons, or 4,000 dump-truck loads of trash per year to fuel a new power plant on the base. The trash, according to KWTX.com will “be turned into energy through a new process that converts trash into gas that’s fed into the plant’s turbines.

Water equals opportunity…

Not too many people are aware of it, but technology companies use enormous amounts of water to produce the microchips that power the millions of iPods, Blackberries and the computer you’re using right now.

For example, Intel uses about 2,300 gallons of water to produce a single six-inch silicon wafer. And local governments have been looking the other way. In a few cases, the local governments have even rolled out the red carpet so these technology companies would bring their high-paying jobs to town.

And right now my colleague Andrew Snyder has just uncovered two cities in the Southwestern United States that have technology companies like Samsung, IBM, Intel and Motorola soaking up more than their fair share of their communities’ dwindling water supplies. These regions are experiencing drought conditions the National Oceanic and Atmospheric Administration deems “extreme” and “exceptional.” In other words, if these droughts were hurricanes, they would be Category 4 and Category 5.

Perfect storm of opportunity

This perfect storm has created a tremendous opportunity for early investors. This company is not going to benefit from price gouging, though. It is going to profit by ensuring that the water keeps flowing to 1.1 million people in America’s Southwest.

The situation is dire. In fact, the ranking member of the U.S. Senate Energy and Natural Resources Committee was recently quoted as saying, “It’s difficult for lawmakers in Washington -- where there’s plenty of water -- to appreciate how dire the situation is.”

This member has had his finger on the water industry for a long time. He and his team learned that water companies benefit in two ways from drought conditions: First, demand for public water is greater because of irrigation needs and sales volume has increased. Second, the increased need to develop new water underground water sources and manage deeper wells pays off for water service companies.

This company doesn’t make pipes, pumps or meters; it installs and manages them. That is where the real profits are. Water utilities and water infrastructure stocks have already experienced solid gains over the last few years. Water service is the next big thing and the possibility of a couple of local governments accidentally creating the 21st century dust bowl is going to make that apparent.

Top 5 U.S. Stocks

1. Western Gas Resources (WGR:NYSE)
(+45.59%)
2. Kerr McGee (KMG:NYSE)
(+36.28%)
3. Penwest Pharmaceuticals (PPCO:NASDAQ)
(+35.92%)
4. Systems Xcellence (SXCIV:NASDAQ)
(+34.22%)
5. Spectrum Control Inc (SPEC:NASDAQ)
(+26.43%)

Western Gas Resources and Kerr McGee both rallied after being bought out by Andarko Petroleum Corp. Andarko will pay $70.50 a share, or a $16.4 billion total, for Kerr McGee, marking a 40% premium over its closing price from yesterday. It will also pay $61 a share for Western Gas, marking a 49% premium over yesterday’s closing price and valuing the company at $4.7 billion.

Penwest Pharmaceuticals traded higher after the FDA-approved Opana, the painkiller the company developed with Endo Pharmaceuticals.

Spectrum Control Inc. gained after reporting earnings. The company grew revenue 23% to $31.9 million. Net profit jumped 31% to $1.7 million.

Top 5 Global Markets

1. Norway OSE
(+2.05%)
2. India BSE
(+1.22%)
3. Philippines PSE
(+0.75%)
4. Malaysia KLSE
(+0.65%)
5. China Shanghai Composite
(+0.60%)

Asian markets were quiet overnight, as investors maintained low volume while looking ahead to the next U.S. Federal Reserve rate hike. Many speculated that a slowing U.S. economy would mean a drop in regional exports. As such, exporter stocks like automakers and consumer electronics companies stumbled.

European indices were mixed as analysts weighed the importance of weak durable goods data in the United States. As has been the theme, M&A was the bright spot for continental bourses. Macquarie Bank paid 264 million pounds for British bus operator Stagecoach. Macquarie also seems likely to make a bid for Associated British Ports, which would rival the offer made by Goldman Sachs. The regional media is also speculating that Arcelor will accept Mittal Steel’s offer this weekend.

Earnings Announcements:
Logility Inc and Summa Industries are releasing earnings.

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Investors Tell the Fed to Take a Hike