Highest Inflation in 26 Years, Short Selling Banned, New ETF, Airline Industry Play, A Changing of the Guard, and More!

by Addison Wiggin & Ian Mathias

  • Inflation soars… consumer costs suddenly rise to multidecade highs
  • The Fed’s dilemma… Bernanke handcuffed by falling financials, rising prices
  • SEC bans form of short selling… Dan Amoss on the effects of the latest regulation
  • Chris Mayer’s play on the struggling airline industry
  • A noteworthy changing of the guard within the S&P 500
  • Plus, abbreviated opportunities abound… a new ETF and the latest SWF debut

  Consumer prices rose 1.1% in June, the biggest monthly inflation swing in 26 years. Not unlike yesterday’s PPI report , today’s release of the latest consumer price index was a doozy… the annual rate of inflation has now risen to 5%, the worst yearly rate in 17 years. 

All measures of inflation blew past consensus expectations in June, even the precious “core rate,” which rose only 0.3%. Energy was the driver of higher consumer prices yet again… prices rose 6.6% in June and are up 24% this year. Gas costs rose 10% in the month, up 32% over the last 12 months. Food and beverages are up 5.2% year over year, another eyesore of an altogether nasty report. 

Here’s consumer inflation, as measured by the government, over the last year… see if you can spot the trend:


But we did manage to find one bright spot: personal computers. If you’re in the market for a new PC, you can rest easy… prices fell 1.4% last month, and nearly 12% from a year prior. Feel better yet?


  “If the CPI were calculated with pre-1983 criteria,” says Christopher Hancock, “the current inflation rate would soar from 5% to 12-13% (a figure more in line with base money supply growth).


“Until 1983, the inflation rate kept respectable pace with M3, the fullest measure of U.S. money supply. But then, alas, came the BLS adjustments. Independent analysts tell us that M3 is now increasing 12% per year, but the inflation rate magically stays at 2-3%.

“We believe these changes to the CPI equation have ushered in an a golden era of ‘silent inflation.’

“Most Americans have been numb to this trend, for several reasons. They’ve paid more to keep up, at the expense of saving less. They fueled their consumption by borrowing off the very roofs that cover their heads. They’ve been convinced the golden train of American prosperity hasn’t passed them by. They believe this myth despite the strikingly negligible increase in real median weekly earnings over the past 25 years.

“The changes to the CPI calculations certainly served Washington’s best interests. They use the inflation rate to index the annual payment increases in everything from your weekly paycheck to government programs such as Medicare and Social Security — the very same programs millions of Americans depend upon every day.”

  Risks to the overall economy are “skewed to the downside,” Ben Bernanke affirmed before Congress yesterday. But inflation “seems likely to move temporarily higher,” and “an unwelcome rise in actual inflation over the longer term,” is possible.

Bernanke testified yesterday (and again today) in a semiannual get-together with Congress. The Fed chief issued a sober forecast, suggesting that housing prices might take a year or more to turn around and that high energy prices were likely to persist.

  Oh… the poor Federal Reserve… they’re really, really screwed. In less than a week’s time, the Fed has faced the fall of Fannie Mae and Freddie Mac (perhaps the biggest “downside risk to growth” of this generation), and now this truly dreadful CPI reading. Rates cannot be raised or lowered… all Bernanke can do is sit before Congress with his hands tied and take his lashings.

  Also on Capitol Hill yesterday, the leader of the SEC announced a ban on the “abusive short selling” of troubled financials. Chris Cox, head of the SEC, told Congress that the SEC will forbid the practice of “naked shorting,” in which the short seller bets against a stock without borrowing shares.

On top of the ban, the SEC has issued a fury of subpoenas to Wall Street firms and U.S. hedge funds. The government regulator is concerned that the spread of unconfirmed rumors unfairly pushed down shares of financials like Fannie Mae, Lehman Bros. and Bear Stearns.

  “I think ‘naked’ short selling must be stopped,” agrees our resident short seller, Dan Amoss. “This practice gives legitimate short selling a bad name. Stock should be located and borrowed before it is sold short, not the other way around. If your broker cannot locate shares to short, the short seller should move onto another idea or use put options.

“But the hysteria about ‘rumors’ bringing down financial companies has gone too far, I think. This is the defense of CEOs who are looking to blame someone for their own incompetence — incompetence that put their firms in vulnerable positions in the first place. Short sellers did not conspire to force Wall Street firms to enter the business of securitizing dodgy debts. Firms like Bear Stearns ruined their own companies with the poor strategic decisions they made.

“Short sellers are beneficial for the market. They provide liquidity at market bottoms by buying to cover their positions, and they are often the first to discover and put an end to accounting frauds and stock promotion schemes that siphon capital away from legitimate businesses.”

If you haven’t heard, Dan’s Strategic Short Report readers just rung the register on their Lehman Brothers puts… for an incredible 450% gain in less than three months. If you’re looking to profit as stocks fall, look no further than Strategic Short Report.

  “My hope is, is that people take a deep breath,” assured President Bush yesterday, “and realize that their deposits are protected by our government.” Our fearless leader even conducted a brief tutorial:

Get ready, here comes some more hot air…


“Despite the challenges we face, our economy has demonstrated remarkable resilience… we will come through this challenge stronger than ever before… I think the [financial] system, basically, is sound…” And on and on.

Ugh… is anyone even listening anymore?

  And our last bit from Washington today — we promise… “We will be proceeding with another stimulus package,” announced House Speaker Nancy Pelosi yesterday. The congresswoman evidently met with several economists and has determined that the first stimulus package was rendered moot by higher food and fuel costs. (Man, that sounds familiar .)

While the second round is still in its infantile stages, we hear the next handout might involve additional rebates, heating and air-conditioning subsidies, infrastructure spending or higher food stamp payments. Hopefully, government will cut us all checks for a million dollars. Then we’ll all be happy, healthy and rich… home prices will suddenly rise, banks will start lending again, and the world will once again recognize us as the most stable, powerful economy in history.

If the “second stimulus” gains enough support, it’ll probably be debated after Congress’ August vacation.

  Oil prices fell $6.45 yesterday, the biggest daily drop in 17 years. Crude traders went racing for the exits yesterday after Ben Benanke’s gloomy testimony mixed with supply disruptions in Brazil and Nigeria.

After opening at $138 a barrel this morning, oil is down another 5 bucks as we write. The weekly Energy Department crude inventory report showed a bigger-than-expected 3 million barrel increase in supply over the past week.

Factor in OPEC’s lowering of its demand expectations on Monday and all signs this week are pointing to falling oil consumption. Thus, crude trades for $133.

  Gasoline, on the other hand, remains on the rise. The national average price at the pump hit another record high today… $4.11 a gallon.

  Falling oil prices appear to be saving the markets this week . The Dow fell as much as 225 points yesterday, but gradually recovered as oil weakened. By the closing bell yesterday, the Dow managed a 0.8% loss.

  Today’s market is a stark reversal of what we’ve grown accustomed to. Indexes are being led to big gains by beaten-down names in financials and — of all things — the airline industry. Delta and American Airlines both issued better-than-anticipated earnings reports today. While both companies reported nasty losses, the Street was expecting a more apocalyptic quarter… most stocks in the commercial airline biz are up over 20% today.

  “The aviation industry still has a big crisis on its hands,” says Chris Mayer. “As a percentage of airline costs, fuel is now about 35% of the total — up from only 13% at the start of the decade. It is the airline industry’s No. 1 expense. The cost of fuel puts enormous pressure on the industry. At the same time, regulators are pushing for cleaner planes with fewer emissions.

“If oil prices stay where they are and nothing else changes, the airline industry will lose about $6 billion this year, compared with a profit of $5.6 billion last year. Many airlines will be taking that familiar stroll into the bankruptcy courts. Globally, 24 airlines have already filed in just last the seven months.

“The industry is trying — and will try — lots of different things to fend off elimination. One of these is to push for more fuel-efficient aircraft. And that is the opportunity for investors to cash in on this crisis.”

So how is Chris investing in this crisis? Cobalt…


Cobalt is a hard metal with a high melting point, which makes it ideal for forming the super-alloys required for more efficient jet engines. To boot, it’s a key ingredient in hybrid car batteries. Chris recently laid out a compelling case for cobalt, along with his favorite metals play, in the latest Mayer’s Special Situations. Get your copy, here.  

  A quick gaze at the makeup of the S&P 500 today shows a notable changing of the guard. For the first time since 1985, the energy sector’s share of the S&P outweighs the financial sector’s. Likewise with health care… that sector’s market cap grew larger than the financials’ this week for the first time since 1992. You might recall the “tree rings” chart we’ve discussed before… looks like history’s repeating.

  Another ETF debuted this week. If you’re looking for a diversified entry into major African markets, check out the Market Vectors Africa Index ETF (AFK). It tracks the Dow Jones Africa Titans 50 Index, the 50 biggest players in the region.

  Gold’s pulled back a bit today. Dollar strength, oil weakness, and some inevitable post-rally profit taking have shaved about $25 off the spot price. You can pick up an ounce of the stuff for $960 today.

  Saudi Arabia has launched its first sovereign wealth fund. It’s called Sanabil al-Saudia, and the oil-rich nation will kick off its SWF with a $5.3 billion war chest. The Saudi government is sitting on another $290 billion in dollar-denominated fixed income investments… if the SWF gets off to a fast start, we wouldn’t at all surprised if the Saudis start dumping the dollars to bankroll their shiny new foreign investment vehicle.

  “It is rare that The 5 indicates such naivete,” writes a reader, “with the remark that ‘new supplies of oil on U.S. territory would both lower prices and decrease our dependence on foreign crude.’ You are, indeed, missing something, namely, that added oil supplies fuel expanded usage (think of all those added cars Tata will be pouring onto India’s roads), along with the fact that just because we find oil off our continental shelf doesn’t mean it flows to the good ol’ USA. China at ever higher prices can simply buy it with that vast hoard of dollars it holds — which, thus, does not eliminate our dependence on foreign crude. As oilman Bush said, we have an addiction to oil, and typically, the smartest way to break an addiction is by not feeding it.”

The 5: We agree, to an extent… we certainly won’t break our dependence on oil by drilling for more.

As for the rest, we don’t necessarily see eye to eye. But our daily 5 Min. are up… we’ll have to tackle this tomorrow.

Thanks for reading,

Ian Mathias
The 5 Min Forecast

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