Daily Insight

U.S. stocks ended a two-day winning streak on Wednesday after some really thoughtless comments from Treasury Secretary Hank Paulson sent the indices lower. Crude prices, which also moved on those comments, hit a new high and as crude gained momentum in the afternoon session stocks continued to slide.

The benchmark indices began the day on a positive note after a better-than-expected factory orders report, but Paulson’s comments over in Europe threw a wet blanket on any momentum.

We’ll get to the specifics of his remarks below, but for now let’s just say that his comments were unwise in the environment with which we find ourselves. The commodity is priced in dollars for heaven’s sake and Paulson is Numeral Uno when it comes to comments on the greenback. He’s essentially stated, I’m going to nothing to boost the dollar value and thus bring crude lower – a killer in this environment. As I type, crude is making a new high, hitting $145.50 per barrel.

Market Activity for July 2, 2008

Basic material stocks led the broad market lower as these shares got thumped, plunging 5.25%. Such a move is strange on a day with which commodity prices were higher. The CRB Index, which tracks the prices for a basket of commodities rose 1.04% -- three days up and three new highs. But worries that the emerging-market economies will slow put pressure on the material stocks -- another indication the rise in commodity prices right here is not so much a function of supply/demand fundamentals as it is speculators being driven to this trade based on what the Fed and Treasury Department are indicating.

Relative strength was found in consumer staples and health-care shares – the indices that track these sectors fell 0.10% and 0.45%, respectively – a pretty good session considering the S&P 500 lost 1.82%.

Getting to Paulson’s statements, which were meant to address the state of housing and the economy in general, he mentioned three headwinds: capital markets turmoil, high energy prices and a continued housing correction.

On two of those topics, nothing but time will ameliorate these issues. The more government planners try to do, the more they will just prolong the situation – just as the Community Reinvestment Act helped to get us into this housing situation. Of course, the Fed’s mistake of keeping rates too low for too long into 2004-early 2005 was the major issue. That’s for another day.

But on oil prices, as mentioned, the Treasury Secretary was quoted as saying “there doesn’t seem to be any obvious short-term solution.” In other words, he is telling traders and speculators to sell the dollar and continue on with the oil trade. (That is how traders interpret these comments in the current environment.)

He’s got to understand a stronger dollar will put a lid on oil prices -- I’m speaking within the policy framework, surely the Israel/Iran thing or a hurricane that makes a direct hit on Gulf of Mexico infrastructure would counteract dollar intervention.

But by refusing to acknowledge this, and thus blocking the G7 from intervening to boost the greenback, it gives a green light to the current dollar/oil positions. Between this guy and Bernanke, I don’t know what to think. They should be working in conjunction to stamp out inflation and give the dollar some life, but their words and actions are delivering the opposite result.

Crude, which had pared pre-market gains, was flat prior to the Paulson comments. However, as the charts below illustrate, oil shot up shortly after those comments hit the wires. The dollar, which was already down, went lower too.

This really is mind-boggling. We could have a concerted effort by Treasury and the Fed – a little intervention from the G7 and mild tightening from the Fed – and oil and the dollar would very likely move in the desired directions again; but, alas, no help. Big policy blunders.

On the economic front, the ADP and Challenger jobs surveys (two preliminary looks at the job data, which about half the time are not even in the ballpark) indicate this morning’s monthly jobs report will show a decline of 80,000 payroll positions. There’s a good chance it may be a bit worse than that as financial service-sector woes will begin to show up in a meaningful way.

If we do get at least an 80,000 decline in payrolls, this will bring the six-month total of job losses to 404,000, or 5% of the eight million jobs created September 2003-December 2007 – a 52-month streak that set a new record for job creation. (You heard virtually nothing of this record streak of job creation as it was occurring, but we’re all bombarded on a daily basis with news of the current job losses.)

In a separate report, the Commerce Department reported that factory orders rose 0.6% in May – marking the third-straight month of increase. The April reading was revised higher to show a 1.3% pick up in activity after being previously estimated at 1.1%

The highlights of the report were computer and electronics orders, up 2.9% in May and shipments of capital goods, up 0.5% That increase followed a nice 1% rise for April.

The capital goods shipments component feeds right into the GDP calculation and will offer a nice boost to second-quarter economic growth so long as June doesn’t show a meaningful decline. As of the data we have currently, we’ll see second-quarter GDP come in at a 2.5% real annual rate – pretty darn good considering housing continues to subtract a full one percent from this reading.

Recession? Certainly things are ugly for the housing and auto industries. Consumer sentiment is reportedly in the dirt – a direct result of sky-high oil prices. But the economy continues to show amazing resilience. We have yet to see one quarter of negative GDP, much less two – the traditional definition of recession. If we get the 2.5% real GDP figure we expect for the second quarter, it will mean the economy grew at an inflation-adjusted rate of 2.25%. That is well below our long-term growth rate of 3.4%, but further from recession that it is from trend growth.

All eyes will be on this morning’s employment report, which will determine the market’s direction. We’ll also get the ISM service-sector index for June. The reading should show the service economy remained in expansion mode for the third-straight month. The January-March period – all registering readings of contraction -- ended a 57-month expansionary streak.

Have a great July 4th – greatest country in the history of the world; thank you Founding Fathers (and the Good Lord for placing them here) – and a great weekend!

Brent Vondera, Senior Analyst