Daily Insight

U.S. stocks built upon Wednesday’s rally, sending the broad-market higher by 3.71% over the past two sessions. Financial and consumer discretionary shares once again led the indices higher, with technology and industrial stocks helping out nicely.

Again, just as on Wednesday, earnings results and a decline in oil prices were the spark. We saw a number of Dow components report very healthy profit growth and the financial sector is delivering results that are surpassing expectations – still weak, but we’ll take what we can get right now.

I’ve got to think the initial jobless claims number, showing claims remain well below the 400K level., also helped to keep things going. The four-week average remains well-below troublesome levels and we just won’t see significant job losses so long as this remains the case – more on that below.

Market Activity for July 17, 2008

Earnings are looking good, outside of the financial sector – and this morning’s releases have turned stock-index futures around. Dow futures were down 100 points a few minutes ago, but have reversed course, down just eight points as I type thanks to additional better-than-expected results. Citigroup has just reported results that beat expectations and Honeywell has knocked the cover off of the ball – 24% operating profit growth, beating their number by 16% and raising full-year guidance. This follows a very nice report from United Technologies yesterday.

A couple of tech names missed their mark yesterday – Google and Microsoft reported income that missed estimates – but the growth rates were stellar. Microsoft reported 25% operating profit growth and Google 33%. Merrill Lynch reported a horrible number last night, losing $4.66 per share, but the rest of the universe is overwhelming their troubles.

To this point, with one-fifth of S&P 500 members reporting, profits have declined 21.4% as financial-sector net income is down 78.8% for the second quarter. However, ex-financial results look ready to record another quarter of double-digit growth, up 12.7% to this point.

The other catalyst over the past two trading sessions has been a welcome decline in oil prices. If we can move down to $125 per barrel that will provide a huge boost to stocks. Personally, I don’t see it happening just yet, although we are finally getting some good comments out of Congress regarding the removal of drilling restrictions – follow this talk up with action and we’re onto something. If not, it will take some mild Fed tightening to really cause a rotation out of the oil trade, in my view.

On the economic front, the Commerce Department reported housing starts jumped 9.1% in June, but that was only because of a change in New York’s building code. That change resulted in a large jump in multi-family units in the Northeast, but excluding this jump starts would have declined 4%.

As the chart below illustrates, starts remain at a lowly level, and it’s tough to picture a sustained bounce until the supply of homes come off of these extremely elevated levels. It will simply take time to reduce this supply, hopefully over the next 12 months we’ll see sales rebound – once they do, the supply figures will fall in pretty quick order.

Residential fixed investment has been a drag on GDP for 10 quarters now. Single-family homes fell 5.3% in June, down 43% year-over-year, but the monthly declines have eased of late. We are probably close to seeing the worst, but foreclosures are the pig still moving through the python, so I’m not sure the bottom in housing can be called just yet. Again, these things just take some time – hopefully we don’t get anymore harmful legislation out of Congress, the more they attempt to be the savior of all of those who made poor decisions the more unintended consequences will result and extend this housing correction.

In a separate report, the Labor Department showed initial jobless claims rose 18,000 in the week ended July 12, but this was less than the 32,000 expected. Remember, the week prior showed a huge decline in claims that was a likely a result of having to adjust to the July 4 holiday. Based on this, there was a concern we’d get a big bounce back to the 380,000-390,000 range. We didn’t though as claims sit at 366,000. The chart below is the four-week average and so long as this reading remains below 400,000, it is very likely job losses will remain tame.

We really need to see things turn a bit and move to mild additions, but this is going to be tough to accomplish until the housing sector comes around – construction-job losses are really weighing on the figure. One glimmer of hope over the short term is what appears to be a rebound in capital spending, which has rebounded, but the jury is out whether it will become a trend. The smart part of the “stimulus” package was the increase in current-year write-down allowance and 50% bonus depreciation for business. This should spark capex and may boost jobs as a result.

In addition to better-than-expected profit results, we’ve received official announcement this morning that Teva Pharmaceuticals, an Israeli company and the world’s largest generic-drug maker, will buy Barr Pharmaceuticals for $7.46 billion in cash – a 41% premium over Barr’s closing price on Wednesday. The deal is helping to boost stock-index futures, so hopefully another nice day is in store.

Have a great weekend!


Brent Vondera, Senior Analyst

Daily Insight

U.S. stocks rallied, sending financial shares to their best one-day performance ever – up 12.3% -- after Wells Fargo posted operating earnings that beat expectations and posted overall stunning results – the firm even raised their dividend. In an environment in which everyone has been expecting the worse out of this sector, the Wells news was more than enough to rally stocks.

Adding to the rally was another significant drop in crude-futures. Oil prices have declined nearly $11 in two days and this helped to ease concerns regarding the consumer; the index that tracks consumer discretionary shares jumped 4.38%.

Industrial and technology shares also enjoyed a nice day, up gained 3.18% and 2.30%, respectively.

Market Activity for July 16, 2008

Oil prices are a bit lower this morning, after falling 7.42% over the previous two sessions, as crude for August delivery stands at $134.06. Yesterday’s weekly energy report showed crude supplies rose 2.95 million barrels; a decline of 2.2 million was expected.

We saw a similar decline during last week’s first two trading session when oil prices fell $9, or 6.5% only to see a rebound back to $145. Hopefully, we have a sustained dropped occurring that gets us close to $125 for now. This would help stock prices out big time and cool the inflation gauges over the next month.

I see many in Congress continue to vilify speculators, citing their behavior as the main reason oil prices have shot up so dramatically. Certainly no one likes it when the market pushes commodity prices higher, but one can’t wish away realities by regulating vital commodity trading markets. I wonder if anyone in Congress happens to ask exactly why market participants have speculated oil prices will go higher. Of course they haven’t – most at least – because they never blame themselves for their own ridiculous policies.

Maybe if there were a sensible energy policy in place, traders wouldn’t bet prices would go meaningfully higher. I doubt anyone would be complaining if speculators were betting prices will fall.

And on the Fed, maybe if the FOMC wouldn’t have implemented such a reckless monetary policy stance, the dollar would be a bit stronger and oil, which is priced in dollars, would be closer to $90 instead of $135. The Fed has thrown the dollar under a bus. But we are trading lower for now, and if Congress removes all restrictions on drilling, we can get a trend started here. I’m not holding my breath, but stranger things have happened.

On the economic front, the Labor Department reported that the consumer price index (CPI) jumped 1.1% in June – that’s on a month-over-month basis – and 5.0% over the past 12 months. We’ve been warning that the consumer-level inflation gauges will rise to 5% before the Fed knows it and here we are. Consumer prices jumped at a seasonally adjusted annual rate of 7.9% in the second quarter and all Benflation Bernanke could say yesterday was that inflation is too high – as if he has zero control over this situation.

Energy accounted for two-thirds of June’s large 1.1% increase, but this didn’t have to be the case if the Fed hadn’t jacked fed funds lower in such an aggressive way. The CPI’s index of energy soared 29.1% at an annual rate in the first-half of 2008. The food component rose 0.8% in June and that specific index within the CPI has risen 6.8% annualized in the first half.

To be fair, the regular CPI does overstate inflation a bit as the index is not capable of quickly adjusting to consumer preferences and the substitution effect – the tendency of consumers to buy more of those goods with which prices are rising more slowing and curtailing consumption of those goods that have prices rising more quickly. Further, the owner’s equivalent rent (OER) segment boosts the housing component as it factors in the cost of renting one’s home instead of owning it. Thus, when the housing market is hurting and more people rent, that results in higher rental prices and pushed the CPI’s housing component higher even when we know home prices are falling. However, there are legitimate segments of this housing component that are pushing CPI higher, such as utility and insurance costs.

Personally, I prefer the chained CPI figure, which we do mention each month, even as the financial press totaling ignored the figure. The chained reading had inflation up 0.8% in June and 4.2% on a year-over-year basis. Certainly higher than we’d like but better at least than the regular CPI reading. Still, if the Fed continues to ignore price stability we will see all of the inflation gauges hitting 5%.

In a separate report, the Commerce Department reported that industrial production rose 0.5% in June after two months of decline. Some of this increase was due the American Axle strike coming to a close, and the negativists obviously suggested that this was a one-time thing and therefore the gains in production will not last. One could also say that the strike, which went on for several months, kept industrial production lower than it otherwise would have been over previous periods.

Other segments boosting industrial production last month were utility output, high-tech production, consumer goods, business equipment and mining activity.

Stock-index futures have done a 180 and are up strong right now after some very good earnings results from Coca-Cola, Untied Technologies and better-than-expected earnings from JP Morgan.

In economic news, we’ll get housing starts for June, the weekly jobless claims figure and manufacturing activity out of the Philadelphia region.

Have a great day!


Brent Vondera, Senior Analyst

Daily Insight

U.S. stocks were all over the map yesterday as the dynamic duo (Fedhead Bernanke and Treasury Sec. Paulson) were on the Hill – which almost always results in market volatility – and a big drop in oil prices helped stocks erase much of a 2.3% early-session decline.

Also we had a slew of economic data out yesterday, and while the inflation data was disturbing – and Bernanke’s dithering, non-committal behavior only causes inflation expectations to erode -- the retail and business sales data were market positives.

Nevertheless, those two economic gauges were not enough to keep stocks positive by session’s close as the S&P 500 closed at its lowest level since late 2005. I’ll repeat though, even if stocks are laggards right now – much of this due to the fact the Fed has created additional uncertainties, in my view – the economy continues to show an awesome level of resilience and I’m not sure our call for a 2.5% second-quarter GDP reading won’t be a bit shy of reality; we may very well get a reading that is closer to 3.0% (in real terms) as core retail sales have risen at a 7.5% annual rate over the past three months – a figure that flows right into GDP.

Market Activity for July 15, 2008

In addition to the Capitol Hill appearance by the dynamic duo, SEC Chairman Chris Cox was also testifying. Of his statements, his comment that naked short-selling would be outlawed regarding financial-sector shares probably garnered the most attention. Naked short-selling is supposedly when someone borrowers the same stock from the same brokerage firm multiple times. What this means is that the person selling short has no intention, or ability, to deliver the shares. I’ve got to be honest, not even sure how this works in reality, but I was under the assumption it was already illegal; it certainly sounds illegal. Maybe what Chairman Cox was saying is now it is really really illegal. Or maybe he found it appropriate to voice the term “naked shorts” in front of members of Congress based on their indecorous behavior.

Moving on…

Crude-oil futures plunged $6.44 per barrel, or 4.44%, yesterday. When this drop occurred at 9:15CT it perfectly coincided with the rally in stocks that brought them back from what looked to be shaping up as an ugly day. President Bush was on the mark yesterday. He was awesome – without tripping himself up even once – on the economy, spelling out a number of positives while acknowledging there are some major challenges that must be dealt with. He was clear, straightforward and on message. Same was true for his statements on the necessity of removing restrictions on domestic energy production.

Naturally, according to the press, it was not Bush’s comments on domestic production that caused crude prices to decline, but the rumor that a bank was failing and had to liquidate their oil positions. So typical. There are a lot of people saying we can’t drill our way out of this situation. I don’t agree. Yes, even if we removed all restrictions on domestic production it would not result in one additional drop of oil, or cubic foot of natural gas, today. But, if the statements are followed with action, it sends a signal and futures prices will respond. Besides, if these restrictions has been removed a decade ago, the energy market would likely not be so uptight.

All of that said, we’ll point out that the crude contract for August delivery expires this week, so this likely has something to do with the precipice drop as well. Crude is down another 1.25% this morning.

On the economic front, the Commerce Department reported that June retail sales rose 0.1%, but excluding autos the figure jumped 0.8%. Core retail sales, which takes out gas station receipts, autos and building materials, rose 0.3%.

We’ve seen consumer activity bounce back very nicely over the past four months, and the rise since April will help to boost Q2 GDP.

In a separate report, Commerce also released business inventories and sales data for May. Inventories rose 0.3% and sales jumped 0.8%, which sent the inventory/sales ratio back to the record low of 1.24 months’ worth of supply.

As the chart below illustrates, business sales remain on a respectable trajectory, up at a 6.3% annualized pace over the past six months – this is not something one sees in an overall weak economy, underlying strength is there. I’ll caution, this sales figure will likely decline when the June figure is released but this will be a very natural occurrence following three months of big gains. Since March, business sales have increased at a 14% annual rate.

Finally, we had the Labor Department’s report on wholesale inflation via the producer price index for June. I’ll let the chart speak for itself.

Despite the troublesome pick up in producer and import prices – import prices are up 20.5% over the past year due to the weak dollar – Bernanke offered nothing that would lead one to believe he is focused on price stability. But reality will continue to ask ol’ Ben how many lumps he wants as it continues to beat him over his Keynesian skull.

In his defense, the consumer-level inflation gauges have remained somewhat tame, although we’ve seen CPI hit 4.2% and this morning’s data is expected to show CPI rose 4.5% year-over-year for June. I find it hard to believe that at least half of the rise in producer prices will not flow to the consumer readings. Inflation works with a lag and I believe the Fed is going to find the inflation gauges hit 5% before they know it. At that point, they’ll be forced to say their Phillips Curve models are flawed – well no, they won’t explicitly admit it – and begin to raise rates. This will actually be a positive event if it occurs, because the sooner they get to it the less aggressively they’ll have to hike.

For now the Fed Chairman is dreamin’ as he continues to state “longer-term inflation expectations remain well anchored.”

On earnings news, Intel reported last night that that operating earnings jumped 45% in the latest quarter as the chip-giant posted record unit shipments of chips for laptops, record shipments for wireless communications and gross margins rose to 55.4% from 53.8%. So that’s good news and provides additional evidence tech-sector profits will record another strong quarter. Recall, Oracle’s 25% rise in operating profit a couple of weeks back that showed the U.S. segment rebounded by 18%.

On a lighter note…

We’ve heard a lot about the “staycation” over the past couple of months. For those not familiar with the term, as it suggests, this is when you can’t afford to actually travel anywhere so you just stay home – as if no one ever stays home when they take time off from work. Anyway, there’s an article in the WSJ touching on how some are pretending to travel – they stay home, but create itineraries for themselves that make it feel like they have gone somewhere. One example was this woman in New York who could not afford a trip to Japan. Instead, she is going to Japanese restaurants, the Bonsai Garden and speaking Japanese for a week. Articles of this type prove there are too many journalists in this country, when you’re struggling to write something and this is what one comes up with it’s pretty clear evidence. We’ve known for some time America has too many lawyers; now it’s clear there are too many journalists too.

Have a great day!


Brent Vondera, Senior Analyst

July 2008 Portfolio Insights

The newest issue of Portfolio Insights has just arrived!

To view the new issue click here or on the cartoon on the right.

Topics include:

• What We Do in Bear Markets
• Investing with Clients
• Fixed Income Strategy
• Equity Markets Activity
• Inside the Economy
• The 2002 Bear Market

Daily Insight

U.S. stocks were dragged lower by financial stocks yesterday on heightened concern bank failures will spread – the S&P 500 index that tracks these shares fell to its lowest level since October 1998, a period which marked the previous financial debacle.

The major indices began the day on a high note, after the Treasury and Federal Reserve stated they’d provide capital to the mortgage GSEs, if needed, but things deteriorated quickly after concerns grew over the status of the banking industry.

Considering the beating the financials endured, down 5.1% yesterday, the benchmark indices held in there pretty well as consumer-staple and energy shares recorded pretty nice results. Health-care, basic material and many industrial shares performed well on a relative basis.

Market Activity for July 14, 2008
Fact is the big banks are very likely well capitalized, in fact they are “well-capitalized” as defined by regulations, but they are also prepared for further deterioration in housing and on the consumer front, such as credit-card defaults – they’ve raised large sums of capital to guard against this likely scenario. However, there will be smaller banks that do go under; although, this is not something to panic over. (Of course, one can’t rule out one of the larger ones taking a header as well if depositors overreact.)

To provide some context, during the S&L crisis of the late 1980s-very early 1990s close to 800 banks and financial institutions failed and the system hardly crashed – this didn’t even push the economy into recession, it took an aggressive Fed tightening campaign in1989 to do that; credit continued to flow. (To this point, I think a grand total of eight banks have gone under thus far – six of those with deposits of less than $60 million in assets –very small players.)

During that financial crisis the bulk of failures occurred 1988-1990, yet consumer loans rose at a 7% annual clip and business loans at a 6% pace. Now, we have the doomsayers – likely holding short positions, I’ll add – stating that the few failures we’ve had thus far will lead to a shut down in credit. Only if people disregard the current state of the economy to focus more on the hyperbole of the moment will credit availability truly crumble.

The charts below show loan activity for consumer and business loans.

Consumer Loans

Business Loans

One of the main problems right now is the way the press, and many analysts, frame things. They act as though depositors will make a run on banks, and that’s trouble enough, but keeping to this rhetoric things can become self-fulfilling. Overall though, we have been through much much worse that this and it’s rather pathetic that we have those of supposed credibility scaring the heck out of people.

Kicking these new concerns off was the seizure of Indymac Bancorp by U.S. regulators on Friday afternoon. But this is not your typical bank as it is a hybridthrift/mortgage bank that specialized in Alt-A mortgages – mortgages that do not require borrowers to document income. The hyperbolic press reporting over the Indymac situation resulted in large banks like Washington Mutual and National City feeling it necessary to release statements that “no unusual depositor or creditor activity” had occurred. And none will unless people become unjustifiably hysterical and cause it to occur. More banks will fail, no doubt about it, but as usual, the press seems to hold context in contempt.

We’ll get through this period, but it will take some time. The economy will have to deal with quarters of weakness squeezed between quarters of pretty decent growth over the next 12 months as I see it. But housing will end its correction at some point and a huge drag on the GDP readings will have passed.

For stocks, there are a lot of names out there that are trading at very low multiples, P/Es that are extremely attractive relative to long-term earnings growth. But one has to be patient as the Fed is not helping things. The administration carts out temporary rebate check schemes instead of jamming a stake in the ground and pushing for more appropriate tax reform and dollar intervention. Yes, Bush’s term is near its end, but one would be amazed at what can be accomplished in an election year. Simply forcing another extension to the current rates on capital, dividends and income – and lowering corporate tax rates, as most of the rest of the world has done – would propel stocks.

Moving on…
I noticed a quote from Senator Obama on Sunday stating, “there is little doubt the U.S. economy is in recession.” To be fair Senator McCain has made similar statements, although I believe he’s refrained from using the “R” word.

Well, that has yet to materialize – recession, that is, as most readers know. Yes, the unemployment rate has risen and corporate profits have been hit by a couple of industries that are in a world of hurt. But real business sales continues to rise, productivity levels remain elevated, the manufacturing sector remains remarkably resilient in the face of housing and auto-industry problems, and, most important, GDP remains positive.

I really don’t get all of the pessimism – I’m speaking of future growth perspectives, surely there are consumers feeling the pain of high energy prices and some pessimism is understandable. But beyond the here and now, all it takes is some policy tweaks, and a couple of industries to turn around slightly and this economy will roar. On a global scale, unless we make some really dumb choices, we will continue to blow everyone else out of the water over the longer-term. But it takes setting in place an appropriate tax policy that boosts after-tax return expectations, instead of an environment in which those that provide the system with capital expect tax rates to harm after-tax returns. It takes a Federal Reserve that actually cares about price stability.

And on this recession speak, which continues in a tone that seems the press actually desires this to occur, watch Q2 GDP hit 2.5% (real terms) as a rebound in consumer activity during April, May and June, strong export growth, decent capital spending increases and the production needed to rebuild low inventory levels overwhelm the drag from the housing sector. Sorry, but this is not recession. Challenges abound, but this amazing and dynamic economy is adjusting to these challenges quite well.

Now, if the market can get a signal tax rates will not change on them, a sensible energy policy is presented and the Fed can get back to focusing on price stability, the stock market will take off and so will the economy. Until then, we’re stuck.

A big day on the economic front this morning as we get producer prices – which will continue to jump to troublesome levels --, June retail sales, and business inventories. That inventory report should show the underlying business sales data remains on an upward trajectory.

The dollar is getting crushed this morning as Bernanke and Paulson will be on the Hill again this morning. Bernanke and the other members of the FOMC. need to signal some gentle rate hiking is coming in order to turn the dollar around and put a lid on oil prices – I sound like a broken record, sorry. Problem is, the market is pretty sure he won’t signal such a move. In short order, he will be forced to as all members of the FOMC are mugged by reality. Their Keynesian-textbook mentality had gotten us into this mess and their errors will be the cudgel with which beats them into submission to hike rates – gently.

Have a great day!

Brent Vondera, Senior Analyst

Fannie & Freddie Update

Fannie and Freddie are still the leading headlines in the news. On Sunday, the Treasury made a major announcement that is positive for the long run viability of the two companies. While Paulson’s recommendations need approval from Congress, it appears that it will get done this week. Once completed, the implied government guarantee that was always attached to Fannie and Freddie is now an explicit guarantee. Here are the main points:

The FOMC approved access for Fannie and Freddie to the Federal Reserve Discount Window. This erases liquidity concerns for the two companies as they can go directly to the Fed to borrow short term cash. Since it has been reported that Fannie and Freddie have a combined $1.5 trillion in unpledged assets, this removes concerns about a short term liquidity crunch.

The Treasury wants to expand its line of credit to the agencies. Fannie and Freddie both currently have a line of credit with the Treasury that they can use for emergency needs. However, this is currently just a $2.5 billion line. This line was established when Fannie held just $15 billion in assets and has never been increased. Speculation is that the line may be increased to $200 billion or more.

The Treasury has asked Congress for the ability to purchase equity in both Fannie and Freddie. There is not yet an actual plan to purchase equity and the form any purchase would take is still in the air. However, if approved, concerns about Fannie and Freddie becoming insolvent and unable to raise capital are eased. The US Treasury is now the backstop, able to provide an unlimited amount of capital to keep the two companies afloat.

The market has applauded this news so far this morning. Investors have renewed confidence in Agency debt as spreads are tightening on both the debt and guaranteed MBS. Freddie Mac auctioned $3 billion worth of discount notes this morning. The auction went very well with the spread tighter than recent issues and strong demand for the issue. Now that it is evident that the government will stand behind the Agencies’ debt, there is little concern for senior debt holders. Most of our fixed income holdings are senior debt issues of Fannie or Freddie.

Fannie and Freddie stock continues to be volatile as shareholders are uncertain about the dilutive affects of any capital injected by the Treasury. This will not be known unless it gets to the point of the Treasury needing to purchase equity. It was reported that Fannie and Freddie would have to agree to terms with the Treasury before any capital injection.

The preferred stock has rallied significantly off of its lows last week. It is still trading at a significant discount and will continue to be volatile until the form of any additional capital is resolved. Any solution that indicates Fannie and Freddie can raise capital and continue to pay dividends on preferred stock will be very beneficial for the preferreds.


Ryan Craft, CFA

Daily Insight

Stocks stormed back from the depths of the intraday low – jumping 2.7% from that nadir – when Reuters reported Fed Chief Bernanke told the mortgage GSEs (Fannie and Freddie) they would have access to the discount window. This way, specifically with regard to Fannie, they could use its $1.5 trillion in unpledged assets as collateral to provide necessary funding, if needed. But minutes later Bernanke denied comment on the news. Stocks summarily lost momentum, but held onto half of the gains from the session’s low.

Benchmark indices began Friday trading lower and were down 2.3% at the lowest point, reached just after noon, as hypothetical situations had taken over and overwhelmed the current state of capital and liquidity positions at Fan and Fred. As three different financial analyst firms stated on Friday morning, home prices would have to decline 40% nationally and delinquency rates would need to rise ten-fold for the two to reach critical capital levels. One assumes it wouldn’t take this level of housing-market deterioration for the two to runs into capital constraints, but the overall point is salient – to this point there isn’t an issue.

The main concern was that hysteria would take over and a state of panic could set in. In light of this, the administration and Federal Reserve decided it important to get a plan out in order to quell this hysteria and to stop short-sellers in their tracks. The Treasury stated they would increase their credit lines to Fan and Fred, and would take an equity stake, if necessary, to inject a level of capital that would get them through a period of trouble. The Federal Reserve also stated they would open the discount window to the two GSEs, again if necessary. So it appears that Reuters’ story was correct.

These statements have calmed the market immensely, for now, as stock futures are up big and common shares of Fan and Fred are up 20% and 30%, respectively in pre-market trading.

Market Activity for July 11, 2008
In other news, the board of Anheuser-Busch agreed to the $50 billion ($70 per share) takeover from InBev last night, so the situation will go to shareholders for approval, which will undoubtedly get the green light.

I seem to be the only one talking about anti-trust issues, and maybe I’m in left field on this one, but I wouldn’t be surprised to see the political landscape attempt to block the deal. I don’t think there are realistic anti-trust problems, but we’ve seen the Justice Department block deals that were less compelling than this one. Antitrust blockage would simply be a pretense for politicians’ desire to keep their constituents happy. Bottom line, if Bud had run their business more efficiently, they’re stock price would have made a deal prohibitive – and of course some of this falls on the Fed for driving the dollar into the dirt, which also made the deal financially appealing to InBev.

Getting to Friday’s economic releases:

First, the Treasury Department reported the monthly budget surplus for June came in at a larger-than-expected level thanks to a 16% decline in spending. On the revenue side, things continue to deteriorate as financial-sector woes have hurt overall profit growth. Yes, several industries continue to post higher year-over-year earnings but the drag from the financial sector is too much for corporate tax receipts to remain positive from year-ago levels.

In addition, we have endured 438,000 payroll job losses since January, and while this is not a large number in a market with 137.6 million payroll positions, it does have an effect on individual tax receipts as the year-ago comparison enjoyed healthy job growth and an expanding tax base.

In a separate report, the Commerce Department stated the trade deficit narrowed in May and illustrated that strong export growth will continue to provide a boost to GDP. Exports rose 0.9% in May and have jumped 25% at an annual rate for the quarter. (This is for the second quarter which has passed, but we must frame it in a sense that it is still ongoing because the data has a large lag to it. We’ll get the June figure next month.)

Finally, the Labor Department reported that import prices for June jumped 20% from the year-ago level – up 2.6% from May alone. Both of these figures were higher-than-expected and the May data was revised higher as well.

Unfortunately, this received zero attention as everyone focused on the Fan/Fred story, but one has to worry that this level of price increases will funnel to the consumer level – as energy is already a major issue for consumers. The Fed continues to clinch, precariously, to their Phillips Curve models. These are Keynesian-economic teachings that state; so long as wage pressures do not present themselves, one doesn’t have to worry about inflation. Problem is, as is the case with most other Keynesian type beliefs, they are often removed from reality.

To my dismay, it doesn’t appear the Fed will raise rates any time over the next several months with all that is occurring related to the housing market, but they better get to some mild tightening regardless of this situation. They can begin by gently raising the fed funds rate 25 basis points at a time, until they get to 3.00% -- I don’t see how this will hurt things regarding the overall economy. In terms of mortgage resets, keeping the rate at 2.00% won’t do any good anyway for all of those that failed to put money down as their home value is currently less than what they own on the mortgage. Benflation Bernanke can push fed funds to zero and these people will still just walk away from their obligation.

The thing that worries me is the longer they ignore inflation and energy price realities, we’ll move to a situation where the Fed will have to jack rates to a level that will be economically harmful in order to get inflation back in its box. They still have time to avert such a scenario in my view, but must get to it.

Have a great day!


Brent Vondera, Senior Analyst