As a result of Friday’s nearly 1% decline on the Dow, the index has virtually moved to bear-market territory. The S&P 500 remains roughly 2% from bear-market levels – which are defined by falling 20% from the top. That top was reached on October 9. The graphs below illustrate was has occurred over the past two years, and specific to this discussion over the past nine months.
Market Activity for June 27, 2008
Today marks the final day of the third quarter and things aren’t looking real nice as the broad market is set to decline 3.4% for the past three months. The poor quarterly results are due to the worst June performance since 1930 – down 8% this month with the final session to go. We were off to such a good quarter too as April was up 4.75% and May add another 1.07%. But oil prices have proven to be too much for the market to handle. Sure, we have a soft labor market and the questions as to the duration of the housing correction, but let’s face it the job-market declines have been mild and housing has been baked in for a while. It’s mostly about the direction of energy prices at this point.Crude-oil futures picked up another 60 cents on Friday, closing the session above $140 per barrel. Crude has jumped 2.2% thus far this morning, moving above $143. I simply don’t see this situation changing until the Fed gets a clue and begins to overtly signal, and then follow words with action, they will begin to raise rates. As we’ve touched on many times, they do not need to raise their benchmark fed funds rate much, just a gentle climb to 3.00% by year end. This will take the steam out of the oil trade and do some amazing things in terms of causing the inflation gauges to decelerate. (Remarkably, the consumer-level inflation indicators remain remarkably tame. This is not so for the producer price and import price gauges, which are through the roof and the worry is that these levels will eventually end up moving to the consumer level. But this has not yet occurred.)
But back to the Fed for a moment, their current decisions are causing traders to keep their long positions regarding the oil trade and have led others to move in as well. According to Bloomberg News, net long positions in New York oil contracts jumped 90.5%. Long positions had touched a five-week low a week earlier as many believed the Fed would make a strong statement that the rate-hiking campaign would begin at their August meeting. Now that another meeting has come and gone, and they were pathetically non-committal with regard to policy, the oil trade goes on.
In addition to all of that, we also have geopolitical concerns pushing oil futures higher this morning, as worries about Iran pick up. Still, I don’t think I’d want to be long oil futures right now. It is a matter of time before the Fed begins to raise rates, they’ll be forced to, and oil should come off big when they do. Geopolitical concerns will remain, but this is why one keeps an allocation to energy and the stocks that provide the equipment to the industry.
On the economic front, the Commerce Department reported that personal incomes shot up in June, jumping 1.9% and sending the year-over-year increase to 6.4%. But much of this was due to rebate checks and the government transfer payments that also went out but were not officially termed “rebate” checks.
During June, $48 billion of rebate checks were delivered so when we adjust for this one-off incomes rose 1.3% last month, still a huge reading. However, there was a purely Keynesian aspect to this “stimulus” program that resulted in people getting checks that were actually more than their actual federal income tax liabilities for 2007. Part of the program was to essentially eliminate the 10% bracket, that’s how they came up with the $600 rebate for most individuals and $1200 for most couples. But others got money as well – a handout is the appropriate term.
You see anyone with income of at least $3,000 in 2007 got at least $300, and since federal tax rates have been driven to zero for individuals making up to $10,000 and couples making up to $20,000, their checks amounted to more than they paid in taxes and those payments were termed “social benefit” outlays. Put all of this together and there were $176.5 billion in government payments that boosted the June income figures. Still, what the media failed to report was that even when you adjust for all of this, June incomes still rose $49 billion, resulting in a 0.4% pick up in incomes for the month. That’s a healthy reading.
I’ve expressed some concern over income growth, especially with energy prices pushing higher, but even when we adjust for the government handouts, June looked good.
Spending jumped 0.8% in June, and has been quite strong from three months now – up 6.8% at an annual rate --, bouncing back very nicely from the respite consumers took during the first couple months of the year. Interestingly, there was $226 billion in income last month when adding in the government handouts, but spending rose just $77.4 billion. Hence, the majority of the “stimulus” handouts were saved, or used to pay down debt.
Overall though, the income (adjusted for the government checks) and spending figures looked good in June and remain on a solid trajectory. Unfortunately, the pace at which energy prices are rising is impossible for income growth to match. In time, very near term in my opinion, the Fed will do its part and this will not be the worry it is today. Their action is belated, but they will be forced to raise as oil will not begin a downtrend until they do.
We’ve got a huge week regarding economic releases. Today we begin with the most important regional factory index – that being Chicago. Tomorrow we get the national reading, which should show manufacturing activity remains very close to expansion mode even as housing and auto-industry woes weigh on the figure. Construction spending for May will also be released on Tuesday. On Thursday we round out the holiday-shortened week with the all-important jobs data for June.
Have a great day!
Brent Vondera, Senior Analyst
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