It will take some time for the equity markets to adjust to this new reality, but it will and I believe this situation will be a positive for investors. Certainly leaving rates where they are and either ignoring the commodity inflation that will surely begin to seep into other areas or pretending that just because growth is weak harmful price increases won’t result is not good for stock prices – outside of higher tax rates, a major market killer is a pernicious bout of inflation.
Nine of the 10 major industry groups lost ground yesterday, as energy was the sole bright spot – the S&P 500 index that tracks these shares gained 0.77%.
Yesterday’s weekly energy report showed crude stockpiles fell well-more than expected, pushing crude futures prices higher and hence the gain in energy producing stocks. I was hoping for a build in inventories, as the previous week’s decline was, at least partially, due to port problems which are now resolved. Alas, this failed to occur.
Crude supplies fell 4.56 million barrels – a decline of just 1.8 million was expected – and this is what shocked the market resulting in the $5 jump in crude for July delivery.
Still, levels aren’t looking bad, as the current inventory of 302.2 million barrels is just slightly below the five-year average and refinery utilization is high, pushing close to 90%, which is nearly full output. Gasoline and distillate (heating oil and diesel) inventories actually rose thanks to refineries banging out product. Fuel consumption was down 1.3%, but electricity use rose 4%, so those pretty much canceled one another out. Electricity production is only partially an oil story as natural gas, coal and nuclear are other sources of this energy, but a 4% increase is pretty big, so it did have its effect on prices.
Too, as we constantly mention, investors/speculators are using oil to guard against a falling dollar and inflation worries. When the Fed begins to hike rates – and they will begin to gently push fed funds higher until they hit 3.00% -- this oil trade will come off, the dollar will strengthen, inflation concerns will wane and stocks will rally. (For sure, there are many uncertainties outside of oil prices and overall inflation, as we’ve exhausted much time touching on, but with crude at these levels any meaningful decline will rally stocks in my opinion. Thankfully, a thoughtless and harmful energy bill failed to achieve the votes needed on Tuesday, so we’ve got that going for us. This would have driven crude futures prices much higher if passed as it focused only on hitting energy producers and forcing utilities to use sources that are not even yet viable, making no mention of increased production.)
These are frustrating times for stock-market investors and tries one’s patience, but these are situations that must be dealt with – they are a reality of investing in stocks. This up and down activity weighs on people – although it is better than moving straight down – but you stay in the game, buying here on the dips. That said, your allocation to stocks must follow your long-term goals and ability to deal with risk.
The graph below shows activity on the S&P 500 since December 2005. We enjoyed the powerful rise to 1550, hit in October 2007, and after dealing with roughly a 20% drop from that top we’ve been range bound.
On the economic front, the Federal Reserve released its latest Beige Book survey (a look at economic conditions within their 12 regional districts every six weeks) and it showed economic activity is muddling around at levels that are just slightly above last year’s.
Much of this data is already known – this report was for the back-half of April and May –but the report is worth a read.
A few interesting points:
- Retail sales were pretty decent in most districts. (We’ve seen evidence of this via last week’s same-store sales data and receive more clues by this morning’s retail sale report.
- Manufacturing continues to hover right around the dividing line between expansion and contraction as housing drags on the sector. While we would like activity to be stronger, we’re not looking too bad considering the housing construction correction and auto industry woes.
- Residential construction remained very weak, but some regions did report buying has picked up as prices have declined. Commercial construction was mixed.
- The energy industry continues to drive growth. The number of active drilling rigs surged, even as a couple of districts stated a bit of constraint due to a slight shortage of equipment. Dallas noted activity reached its highest level in 20 years.
- Labor market conditions loosened a bit but skilled positions remained tight. This corresponds to the small business survey we cited a couple of days back that mentioned the availability of skilled labor is among their top concerns.
In a separate report, the Treasury Department reported the May budget deficit jumped to $165 billion due to the Treasury sending out those rebate checks -- a completely stupid idea that will do little to boost economic growth – it would have been far better to pass current tax rate permanence, which would have moved stocks higher. In addition, consumer consumption patterns are determined more by their longer-term after-tax income expectations than by transitory changes.
The May deficit was larger than the entire 2007 shortfall. Last year’s deficit was essentially non-existent thanks to soaring tax receipts, and is probably a reason we didn’t here the press talking about it. One can be sure much attention will be given to this year’s shortfall.
Anyway, what I found interesting was that when you adjust for the $50 billion in rebate checks that went out individual tax receipts were 5% higher than the year-ago period. This signals the job market, while soft, is not terribly weak or this would not have been the case.
Have a great day!
Brent Vondera, Senior Analyst
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