Consumer discretionary shares led the advance as oil prices declined and investors pushed these shares higher after Thursday’s very good retail sales report. The group didn’t gain much ground in the previous session even though that May retail report justified a nice move higher; what we saw on Friday was likely some flow through there.
Energy, basic material, financial and technology shares also performed very well. All 10 major S&P 500 industry groups ended the session higher.
Oil prices declined on Friday, not by a lot but we’ll take what we can get for now. We have received some nice comments from G7 members this weekend as their main focus was commodity prices. So long as the group focuses on rising energy and food prices as their major concern regarding future economic growth I think we may see a lid put on oil prices as the dollar will get some support. In the end, either the Fed will have to begin to gently raise rates, the G7 will have to back their words up with action of intervention, or a combination of the two before the dollar can get back to 80 on the Dollar Index (currently it stands at 73.75 – the 80-85 range is the optimal dollar level in my view) and oil goes meaningfully lower. We need to see the G7 take charge here for once. While the dollar has stabilized of late, it would be very harmful for both the U.S. and global growth if the greenback were to test the 70 handle again as it did in mid March.
The dollar posted its biggest weekly climb since 2005 as more expect the Fed will need to tighten policy a bit and on those G7 comments. I should note that the group meeting these days is actually the G8, but I choose to go by the G7 still as Russia, the latest entrant, is nothing but a thorn in everyone’s side and brings virtually nothing to the table – nothing productive at least.
This weekend we also saw that Saudi Arabia has chosen to boost production by 550,000 barrels per day beginning next month. This will bring their daily production to roughly 10 million barrels. It appears that Bush trip a couple of weeks back actually was effective – it was reported at the time that he went hat-in-hand to the Saudi’s and came back with nothing. I don’t think it is a coincidence that they are suddenly announcing a boost to production as the President likely reminded the Saudi Family it is the U.S. that stands between them and an Iranian regime that would love to invade as Mideast hegemony is their primary goal.Another key factor is also that OPEC fears the fact that crude prices have remained at these lofty levels. They know if crude in the $130 range is sustained for a meaningful period of time that alternatives will eventually account for a larger percentage of our sources of energy. As they see it, better for them to lower the price a bit via higher production then allow alternatives to bring prices crashing lower.
This is one reason why many of the alternatives that are looked upon as the panacea for our energy issues are simply difficult to bring to market in a cost effective way. This is not the way the world is currently set up. For alternatives such as solar, geothermal and coal-to-gas, we need the current price of oil to remain at these levels or the capital simply won’t be there to bring it to market in a way that significantly lowers the price. Fact is fossil fuels are still the cheapest source. The really unfortunate thing is that we could break the back of OPEC if we only had the will to drill for all known reserves within our own land and engaged in a policy to power the “grid” solely with nuclear and coal. This would bring crude and natural gas prices much lower, and these are the sources with which OPEC currently provides roughly 40% of world supply.
On the economic front, the Labor Department reported the May CPI (consumer price index) reading came in at 4.2% from the year-ago period – CPI has been hovering around 4% since December. For the month, the reading showed no sign of abating, rising 0.6% in May alone. The core rate, which excludes food and energy, does remain tame, rising just 0.2% in May and 2.3% from the year-ago period.
I’ll note, when we average all three major inflation gauges overall inflation is running at 3.5%.
The Fed continues to focus on the core reading. We have argued they need to drop this look and focus only on the headline figure as food and energy prices are the real issue. The significance of the core rate is that it shows high energy prices are not fully flowing through to the costs of other items. We can thank strong productivity improvements for this, but the Fed ought not expect either energy prices to come lower simply because growth is weak or that these higher energy prices do not cause other problems. Firms are eating these higher costs and this could hurt profit growth down the road. A little rate-hiking could go a long way, and outside of the conventional wisdom may just be quite positive for both economic and profit growth.
As the whole point of this morning’s commentary suggests, higher energy prices were the driver of the CPI report. The energy component jumped 4.4% in May as gas and electricity was up 2.3% and gasoline up 5.7%.On the optimistic side of things, medical care costs have really stabilized rising just 0.1% each month since February, which is nice. Most of the other components don’t look bad either; it’s just the energy side of things and some food prices. Fed can take care of this energy move, just do it.
Have a great day!
Brent Vondera, Senior Analyst
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