Daily Insight

U.S. stocks took a beating yesterday as the Fed has created additional problems for equity investors after failing to provide strong and decisive language regarding near-term monetary policy. The lack of conviction is making it difficult to assign an appropriate market multiple to the broad market as inflation concerns increase; oil has gotten back on its horse and seems quite ready to move higher so long as the FOMC remains non-committal.

The Dow Industrial average moved to its lowest level since September 2006 and the Dow Transports have gotten hammered in the past five trading sessions, falling 7.5%. Still the trannies have held up remarkably well, up 7% year-to-date. The S&P 500 has held above the March 10 multi-year low, but just barely as a 1% decline from here will move us through that level.

Market Activity for June 26, 2008
For what it’s worth, the U.S. indices are holding up better than most markets. Year-to-date, Germany is down 14.12%; France is off by 15.57; Britain is down 14%; Spain has declined 14.10% -- and that’s with currency adjustment. In addition, Hong Kong is down 20.7%; China’s major index has plunged 45%; India is off by 32%.

Crude-oil futures, enabled by the Fed and the driver of Benflation, rose 3.78% yesterday and are adding to that move this morning, rising above $140 per barrel. The chart below shows activity for yesterday’s session. Some of this activity includes the previous day’s overnight session, but you can tell by the time on the x axis how momentum began to build early morning and exploded to the upside by the time of our market open. (That momentum actually occurred directly following the release of Wednesday’s Fed decision as crude, which had been lower for most of the day by $4, reversed course and recovered half of that loss.

On the economic front, the data wasn’t too bad really, actually quite good regarding the GDP when considering all of the recession predictions.

Oh, before getting into that, I neglected to mention yesterday that Oracle’s latest earnings results were strong, propelled by the U.S.-dominated Americas region. Overall, quarterly profit advanced 27%, with U.S. sales bouncing back to record 18% growth.

As we’ve talked about many times, there are certainly areas of the U.S. economy that are hurting – housing and autos, namely – but other segments remain quite healthy. This news out of Oracle is just another example. A prime example of this reality, which we touch on each month, is business sales, which are up 6.75% over the past year and have increased at an 8.5% annual pace thus for during 2008. This data does have a big lag to it; the latest data is for April. That said, based on the trends of May and June, I expect this data to remain on an upward trajectory.

But back to yesterday’s economic releases, the Commerce Department reported that first-quarter GDP was revised slightly higher to 1% at an annual pace – that’s in real term, adjusted for inflation.

The drivers of first-quarter activity were personal consumption – always the largest segment of growth --, which added 0.81 percentage point; net exports, which added 0.79 percentage point; and government spending, adding 0.41 percentage point.

The drag continues to be residential fixed investment – housing --, which subtracted 1.12 percentage points from that real GDP figure. This amounts to a 24.6% decline at an annual rate – again, this is for housing construction.

Inventory additions added virtually nothing to first-quarter GDP, after subtracting a large 1.79 percentage points from the fourth-quarter number. Watch as the production needed to rebuild inventories fuels second-quarter GDP. Personal consumption and business spending will also add nicely, and unless the lagging data (mostly for June, but we still have a couple of releases we have yet to see for May) record uglier numbers than I’m expecting, the next GDP report will be stronger than most estimate and will continue to crush the recession predictions.

Growth is certainly weak, but it’s a far cry from recession – traditional definition of which is two-straight quarters of negative readings. My main caveat at this point is the Fed. They are fueling a commodity boom and their latest statements make it appear they are oblivious of this fact. They continue to believe that weak growth will bring these prices lower – I guess we’ll watch this assessment continue to miss the mark. If they don’t wake up, the interest rate increases that will be necessary to regain inflation-fighting credibility will lead to recession in the back-half of 2009.

In a separate report, the National Association of Realtors reported that existing home sales rose 2.0% in May. That’s certainly welcome news, but the inventory levels remain extremely elevated – as the second chart below illustrates -- so it’s tough to get excited about the increase in sales. Fact is this housing correction will be with us for a while. If only the Fed would get it right we will adjust to the housing woes. Assuming Congressional chicanery doesn’t exacerbate the situation, my feel is housing will begin to flatten out a year from now.

It’s important to point out that real economic growth has increased 2.5% over the past four quarters. That’s with housing subtracting more than one percentage point during three of those quarters and high fuel prices that continue to rise. For perspective, the long-term average for real U.S. growth – or what is referred to as “trend growth” – is 3.4%.

Lastly, the Labor Department reported that initial jobless claims came in flat from the previous week’s reading. For the week ended June 21 claims remained at 384,000, which is a bit higher than we would like. In the currently soft job market environment, we’d like to see claims hovering around 365,000-375,000 – this level would give us confidence that the monthly job losses would remain very tame. The current level of claims is not terrible, so long as we remain below 400,000 it is unlikely we’ll see a sharp monthly decline in payroll jobs, but still a small decline from here would make me more comfortable especially regarding the outlook for income growth.

This morning we get the May figures for personal income and spending, along with the inflation gauge tied to it all.

It will be tough for the equity markets to advance today, as traders will not want to go into the weekend long with the uncertainties that surround. But if the income and spending numbers come in at a healthy pace, stocks could get a boost. The inflation gauge tied to personal spending – known as the personal consumption expenditures index, or PCE – will show consumer-level inflation remains fairly tame. But this will change if the import and producer price figures remain at current levels and the Fed fails to put the hurt on the oil trade. If they fail to get it right, we’ll see the inflation gauges hit 4.5%-5.0% and then the bozos will be forced to act.

Have a great weekend!

Brent Vondera, Senior Analyst