Daily Insight

U.S. stocks rallied yesterday as comments from JP Morgan CEO James Dimon sparked a rally in financial shares and oil continued a two-day slide. Earnings season kicks off this morning, although doesn’t begin in earnest until next week; we’ll have to get better-than-expected numbers for stocks to trend higher in the very short term.

Financial shares led the gains, jumping 5.72%, after JP Morgan’s Dimon stated losses in credit markets will ease. Industrial, transportation and consumer discretionary also enjoyed a nice session as crude futures fell $5.33, or 3.77% -- ending a two-day slide of more than $9.25 per barrel.

On earnings, we expect ex-financial profits to remain positive – although things won’t be strong enough to match the past two quarters of double-digit growth. Tech, consumer staple, health-care and industrial-company profit growth should combine to help ex-financial profits to post 5-6% growth. Financial profits will plummet another 60%, likely, but this is expected and once we get out another couple of quarters this sector’s earnings should rebound in pretty strong fashion as the comps will be easy to beat.

Market Activity for July 8, 2008

It’s been very nice to see oil prices come back below $140, falling to $136.04 as of yesterday’s close. The dollar posted a very nice day too as the G7 members made some very constructive comments on inflation – which means they focused on these two variables and may have sparked some fear in those holding dollar short positions. Alas, crude is up $2 this morning on reports Iran tested a longer-range missile capable of reaching Israel.

On stocks, they’ll remain volatile and will probably find it difficult to gain momentum in the very short term as uncertainties abound. The Fed, with their reckless easing policy of the past several months, has thrown another risk into the mix – inflation concerns – and this makes it increasingly difficult for the market to determine the appropriate market multiple. Other risks are geopolitical events – which is something we’ll have to adjust to for several years –, tax and trade policy, and energy price volatility.

We have heard talk of another “stimulus” plan – but Washington needs to spare us all of their feckless Keynesian shot-in-the-arm rebate check approach and get to making the current rates on income, capital and dividends permanent while also lowering the corporate tax. This is what should be done for now, and will cause the market to rally.

Once we get the election behind us, it will be important to lower all of these rates a bit further. This will cause the dollar to rally, profits to boom, stocks to rise, the job market to expand and disposable income growth to extend upon the very nice gains of the past few years. Enough of the games, it is time to get back into the game and show a very competitive global economy exactly who is king. It is the U.S., and it will remain the U.S. even if we have to deal with politicians that are more inclined to a framework of socialism than capitalism in the short term. Any big mistakes of the next two years will only bring back pro-growth policies and this country will continue to lead the global economic growth. If we escape this tendency – that more government involvement is the answer -- all the better. But mark my words, we will make the correct long-run choices of providing an environment for entrepreneurs and innovators to flourish as common sense policies allow capital formation to build. That is America and will remain that way.

Currently, we are dealing with monetary policy mistakes. As the Fed kept rates too low for too long into 2005. This policy fueled the housing market problems as the FOMC subsidized debt and encouraged some very bad behavior. Now we are working to resolve this issue. Again though, Bernanke & Co. are making the same mistake and this is fueling a commodity boom, and raising inflation expectations. I’m still holding out for the Fed to come around and reverse course. They better get to it. When they wake up the energy problem will ease dramatically. Yes, we have other challenges in this regard, such as pushing aside quixotic tendencies for common sense energy policy, geopolitical risks and the chance a hurricane may take a damaging path. But specifically within the economy, it is all about the Fed and a little tightening will solve the oil/dollar problem.

On the economic front, things were mixed.

The Commerce Department reported wholesale inventories hit the lowest level on record in May even as auto stockpiles remain elevated. Thankfully, most businesses have kept their operations lean and sales remain strong. Sales growth is up 13.6% year-over-year and up 20% at an annual rate over the past three months.

This data indicates two things:

One the economy will not go into recession anytime soon as firms have kept stockpiles lean. Remember, a big contributor to downturns is when firms become bloated and then have to sell off a surplus of goods before ramping production up again. This is certainly not the case today.

Two, underlying growth remains, as evidenced by sales growth. Sales have easily outpaced inflation, so one cannot say this growth is solely a function of rising prices – real sales growth looks good.

That said, we very likely see sales decline when the June data is releases. After three very strong months, a pull-back is a natural occurrence. So be prepared for that as the media will attempt to spread their doom and gloom when it occurs.

Regarding GDP, the large inventory rebuilding of the past two months will result in a stronger-than-expected reading. We’ll see second-quarter GDP come in at 2.5% in real terms by my estimation – assuming nothing huge changes over the next month – the lagging data for June has yet to be reported.

We also had pending home sales, which fell 4.7% for May after large 7.1% rise in April, which was revised higher.

Even with the pull-back last month, the year-over-year trend is looking much better. (The graph below shows the month-over-month change.) In December, the year-over year decline in pending home sales reached 23.9%. As of this latest data, that figure has improved to a decline of 14.6%. Let’s hope we continue to see mild improvement. Still, for things to really turn buyers will have to believe prices have bottomed. Until then, the sales figures will remain weak and supply will remain elevated.

We’re quiet on the economic front this morning, so we’ll have to wait for tomorrow’s jobless claims and chain-store sales data.

Oh, I almost forgot to mention both Fedhead Bernanke and Treasury Secretary Paulson gave speeches yesterday and the market held onto its gains. Let’s hope this is the start of a new trend – talk about quixotic.

Have a great day!

Brent Vondera, Senior Analyst