Not-So Great Expectations

The Daily Reckoning – Weekend Edition

April 14-15, 2007

Baltimore, Maryland

by Kate "Short Fuse" Incontrera

VIEWS FROM THE FUSE: NOT-SO GREAT EXPECTATIONS

The American consumer is cautiously looking over the rim of their rose-colored glasses and holding on tight to their pocketbook…at least for the time being.

The Expectations Index, a predictor of consumer spending, fell to its lowest point since August this month. Additionally, the Consumer Sentiment Index has fallen for three months in a row, based mainly on inflation fears, rising commodity prices, and a flailing housing market.

Although minutes from the Federal Reserve’s March meeting showed that central bankers expect core inflation to gradually subside, they still cite "uncomfortably high" inflation readings as their biggest concern for the U.S. economy.

Apparently, so does the average citizen. The University of Michigan report that was released Friday showed that Americans have raised their outlook for inflation to a rate of 3.3% from the previous 3%.

Forbes.com reports: "Inflationary expectations have the ability to influence actual inflation, since workers fearing higher prices are likely to demand compensatory raises and investors will want interest rates that compensate them for the risk that their dollars will have reduced purchasing power when their bonds mature."

Also tightening on American’s purse strings is the news that home prices may fall 20% due to the rising amount of defaults on subprime and Alt-A loans. Some experts predict that as many as 40 percent of these loans could default, causing more than just a ripple throughout the U.S. economy.

"It would be the biggest housing-price decline since the Great Depression," said Kenneth Heebner, manager of the top-performing real estate fund over the past decade.

"That would leave home prices at levels last seen in 2003 and 2004, the middle of the boom that lifted prices to a record in 2005."

Which spells trouble for everyone who has refinanced in the past few years…the price of your house has gone down – but you still owe all of the money.

No wonder people aren’t going out to eat as much…well, that and the fact that the price of your steak dinner just went up. Commodities such as red meat…cereal…soft drinks and milk are on the rise, thanks to the ethanol boom.

As one of Kevin Kerr’s Resource Trader Alert readers pointed out in a recent email: "As you know, corn is the least practical commodity source for ethanol, sugar cane being far more preferable. But who wants or needs ethanol, anyway?

"Unknowingly (I pray), Bush and the Congress have come up with a great solution for the illegal immigration problem. Instead of feeding the world with the essential staples of corn, soybeans and rice, the beltway crowd has decided to flush these vital foods down the gas tank in the form of ethanol, thereby starving out the poor of the world by making tortillas and beans, etc., unaffordable.

"Corn is the most universal agricultural and widely applied staple in the world. My expectation is that dramatic food cost inflation is unavoidable and lies just ahead."

Short Fuse

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THIS WEEK in THE DAILY RECKONING: Financial earthquakes…surging uranium prices…the latest in oilfield technology – we hit all of these subject in the past seven days of issues, catalogued for you below…

Limbic Medals 04/13/07

by Bill Bonner

"Research shows that the brain has two centers for decision-making. This data has been said to explain why Americans save so little – one part of the brain told them they should put their paycheck in the bank, but the other insisted on buying a new wide-screen TV. In this DR Classique, first run in April of 2005, Bill Bonner takes a look into these parts of the brain…"

The Alchemist of the Oil Patch 04/12/07

by Dan Amoss, CFA "Opinions differ about future capabilities of oilfield technology…both sides have valid points, but Dan Amoss feels that it’s important to remain focused on progress underway and depletion of large existing fields…"

Zimbabwe: Best Performing Stock Market in 2007? 04/11/07

by John Paul Koning

"With all that’s going on in the U.S. markets right now, it’s easy to overlook an area like Zimbabwe – at least in a financial sense. But, as John Paul Koning explains, failing to notice this market could be a colossal mistake. Read on…"

Stealth Uranium Investments 04/10/07

by Doug Casey

"Uranium prices have been through the roof lately – surging 57% this year alone. And while the future of this commodity looks bright, the so-so stocks attached to this metal present a serious investment challenge. Luckily, our friends at Casey Research have uncovered the subsectors of the uranium space that have been largely unrecognized by the average investor. Read on…"

Financial Earthquakes 04/09/07

by The Mogambo Guru

"If preventing inflation and boom/bust cycles is the reason the Fed took over the power of America’s money supply, why are we currently experiencing the negative effects of each of these economic phenomenon? Is there no one who will stand up and point out this injustice? The Mogambo Guru, ladies and gentlemen…"

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FLOTSAM AND JETSAM: Some of today’s biggest acquirers of companies are firms from Russia, India and China. Chris Mayer looks at one of the big trends shaping markets today, below…

The Russians Are Coming – so Is Everyone Else

by Chris Mayer

The Financial Times featured a little blurb about Russia’s acquisitive global titans in a piece titled "The Russians Are Coming": "The value of deals by Russian companies overseas has soared, from just over $1 billion in 2002 to more than $13 billion last year."

Based on United Nations’ estimates, Russia is now the third largest foreign investor among developed countries.

On the surface, this vigor from Russian firms is interesting by itself, because it is unusual. It is even historic. I can’t recall a time in recent history when Russian firms played so large a role in international finance. It also affirms that the Russian economy is making progress. Russian companies are making money. Russian management teams have ambitions. All of these factors will have ripple effects – beyond just the commodities markets. Last week, Aeroflot – a Russian airline – announced it was part of a consortium bidding for Alitalia, the Italian airline.

It’s not only the Russians, which makes things even more interesting. The Economist reports that Indian firms bought 34 companies, for $10.7 billion – that’s just so far this year. They trail just the Russians, who have spent $11.4 billion in their investing abroad this year.

The Economist notes: "While globalization has opened up new markets to rich-world companies, it has also given birth to a pack of fast-moving, sharp-toothed new multinationals that are emerging from the poor world."

It will be fun to watch all of this unfold. As investors, we’ll have to figure it all out and bet accordingly. One of the first things we’ll have to do is shed any old notions that these foreign firms are backward low-cost providers. As The Economist says, "They already possess a formidable array of skills, such as managing relations with customers, polishing brands, building up know-how and fostering innovation."

Editor’s Note: Chris Mayer is a veteran of the banking industry, specifically in the area of corporate lending. A financial writer since 1998, Mr. Mayer’s essays have appeared in a wide variety of publications, from the Mises.org Daily Article series to here in The Daily Reckoning. He is the editor of Mayer’s Special Situations and Capital and Crisis – formerly the Fleet Street Letter.

The above essay was taken from the latest issue of Capital & Crisis.