Daily Insight

U.S. stock indices ended mixed on the final day of the second quarter as the Dow and S&P 500 managed small gains, while the NASDAQ Composite closed lower. The opposite was the case for the quarter, however, as the Dow and S&P 500 ended the period lower – the third-straight quarter of losses – and the NASDAQ managed a fractional gain.

The Dow closed the quarter down 7.44%; the S&P 500 declined 3.23%; the NASDAQ Composite gained 0.61%

The Dow’s string of three consecutive quarterly losses has not occurred since 1977 when the index recorded losses in each of that year’s four quarters. (For the S&P 500 we have had two other occasions since 2000 when the measure was off for three straight quarterly periods – first nine months of 2002 and the final nine months of 2000.)

We don’t want to get ourselves into a situation where comparisons to the 1970s become relevant, especially with regard to inflation. And on that topic, Bernanke & Co. better well get a handle on benflation expectations or stock prices may just begin to price in harmful levels of price activity – even as the consumer-level gauges remain pretty tame for now. One cannot ignore the jump in energy prices, and commodities in general, or suggest that these costs will come lower simply because economic growth is weak. This is what the Fed has been saying, and the thought has been terribly wrong to this point; I’ve got a sense they’ll be forced to throw their Keynesian-style thinking aside in the very near term.

Market Activity for June 30, 2008
The financial sector, to no one’s surprise, led the broad market lower for the quarter as the index that tracks these shares tumbled 19.01%. The next worst performer was the industrial group. Six of the 10 major industry groups declined during the prior three months.

Energy, again no surprise, led the gainers, jumping 16.92% for the three months ended June 30, as oil jumped 38%. Such a quarterly increase (in percentage terms) has not occurred since 1999, but back then oil per barrel was trading at $12-$16 per barrel, so it was just a touch easier to deal with. The lunatic fringe may begin to surmise that Bernanke has some family members with oil-company interests if this pace continues. This would be an illogical view, but there’s little arguing his easy money ways hasn’t had adverse effects on the dollar and the price of oil.

Interestingly, removing the financials from the S&P 500 the index was basically flat during the prior three months, down just 0.38% -- financials were responsible for 285 basis points of the 3.23% decline. I’m not sure if thinking of things this way makes much sense, but thought it was worth pointing out. Financials make up 14.2% of the S&P 500 at present, which is down from 16.8% when the quarter began and 21.42% just two years ago.

I look at the benchmark indices, and many of the stocks that make up these measures, and see a lot of value. There are an abundant number of stocks trading at multiples that have compressed to levels that make very little sense based on their current earnings growth and potential of the next several years. In time the equity indices will explode to the upside as stocks are spring loaded after several years of earnings growth far outpacing the rise in share prices.

But for now, investors will simply have to be patient because uncertainties abound and the Fed has thrown one more in with their easy money policy. Maybe I’m way off base here, but as most readers know, my belief is oil will fall back to the $100-$110 level if Bernanke would just mildly raise rates. This would bring inflation expectations lower and remove a major risk (not just on an expectations level but will relieve some pressure on the consumer) as we deal with the current housing-sector woes and concern over tax and trade policy – a concern that increases each day Senator Obama makes a speech about how he’s going to jack rates up on the people that provide our economy with capital, which is about every day by my count. In addition, placing windfall” profit taxes on oil producers (more production is something we can really use right now) won’t be kind either as this will increase out dependence on energy imports, just as the same scheme drove the industry to other areas of the globe during the late 1970s.

Enough of that. On the economic front, the Chicago Purchasing Manager’s report – factory activity for the most important manufacturing region – showed mild improvement within the sector continues, as the index crept even closer to the expansionary mark.

The reading came in at 49.6; a reading of 48 was expected. As we’ve stated for a few weeks now, it does appear the manufacturing sector is poised to record expansionary reading once again – it’s been six months since we’ve been solidly above the line of expansion, which is 50 on these indices.

Yes, it will take a flattening out in housing before factory activity moves markedly into expansion mode – by markedly we mean readings of 55-56. However, we are already right at the line of demarcation and should mover above the 50-mark within a couple of months – even with current housing and auto-industry challenges.

We’ll get a better look this morning when the national factory index – known and ISM Manufacturing – is released. We’ll have to deal with another reading that remains just barely in contraction mode, but should see some signs that things continue to slowly improve as underlying strengths help the sector fight through the areas of weakness.

Have a great day!

Brent Vondera, Senior Analyst