Benflation Bernanke and Treasury Secretary Paulson were on the Hill yesterday talking about regulatory issues. In the meantime, Paulson attempted to dissipate the concerns over the GSEs – another attempt denied – as he repeated that the two mortgage giants were “well-capitalized.” If home prices fall significantly from here and foreclosures ramp up, then this “well-capitalized” position may not hold, but the government will backstop the two from failing.
It’s as simple as this. If the Federal Reserve felt it necessary to assist in keeping Bear Stearns from going down, of course the Treasury and Congress will step in to provide some funds for Fan and Fred to get through the housing woes. The government may very well take the two over if they find if difficult to raise private funds – enough of beating around the bush anyway, they’re not letting the two fail if it came to that. In the meantime the common stock continues to get crushed as these shareholders will endure further dilution if/when they do raise more capital.
Just to clarify, the mortgage-backed securities are a completely different story. These bonds are collateralized by the underlying mortgages. As long as the homeowner makes their payment, the bondholder receives his/her payment. If a mortgage goes delinquent or defaults, then FNM and FRE take the loss and pay the bondholder all principal and interest. These are conventional mortgages.
On the regulatory issues, it appears Paulson would like the Federal Reserve to be granted more oversight authority. Wrong! They are already responsible for banking-industry oversight and dropped the ball in that regard. No, they don’t need any more authority, please.
Market Activity for July 10, 2008
The chart below shows the circuitous path the S&P 500 took on the way to 1253. At one point in the afternoon session the index was just about 2% off the intraday high, but rebounded nicely in the final hour. 
In the end, none of this really matters – I show these intraday charts on occasion just to provide a visual. We’re likely in one of those periods where stocks take a while to find the appropriate multiple at which to trade. Additional Fed policy mistakes throw the biggest stock uncertainty of all into the mix – the risk of a harmful bout of inflation – but as we’ve stated before, earnings growth has significantly outpaced stock prices over the past five years. After-tax corporate profits are up 175% since December 2001, while the NYSE Composite is up just 38.8%. Stocks are spring-loaded to deliver outsized returns over the next decade, but we must get past a number of uncertainties first.General Electric has just released their second-quarter earnings results, which are in-line with expectations. Overall, operating profit was flat from the year-ago period. Flat isn’t great, but I’ll point out that the year-ago period was a strong one – up 22%. So to come in at that level, is not all bad. Sales recorded a nice gain, up 11%. Backlog is looking strong. Their infrastructure business was up 24%. Health-care equipment rose 8% -- the previous quarter’s decline concerned a lot of people, but you may recall we mentioned that decline was a fluke. Overall growth will come around. In the meantime the stock trades at just 12 times earnings and a dividend yield of 4.48%. The company has increased the dividend payout by 10% a year over the past five years.
Moving on to macro issues…
The graphs below, source Credit Sights, shows the percentage change of capital spending activity for 2007. While the risk remains that 2008 spending plans may be reduced, the data of late shows (specifically via factory and durable goods orders) that healthy growth will continue through this year. You can see the number of firms increasing outlays far outweigh those reducing. The same trend is true for 2008.
This is very good news with regard to GDP over the next few quarters. I continue to be concerned over real personal income growth -- particularly in the face of rising commodity costs -- for the next several months as its unlikely we’ll see any job creation for a spell, but this segment (capital goods orders) of the economy will help to keep GDP positive. At this point, I believe GDP will come in at a 2.5% real rate for the second-quarter. This estimate will depend on some of the lagging indicators that we have yet to see for June, but to this point consumer spending, capital investment, exports and inventory rebuilding will overwhelm the continued drag from housing.
In economic news, the labor department reported that initial jobless claims plunged 58,000 in the week ended July 5, falling back to the pretty low level of 346,000. Some of this decline was due to seasonal adjustment issues, but the fact that we have dropped far-below the level of 404,000 reached in the previous week shows the labor market losses will remain tame for now. The four-week average, a less volatile figure, has edged lower. It currently sits at 380,000 – the chart provides the picture.
Continuing claims remain elevated, but still well-below true job-market weakness, as the chart below illustrates. Also factor in that the workforce is much stronger than those previous periods, so a level of 3.2 million in continuing claims is not what it used to be. Continuing claims being defined as those that have accepted jobless benefits for more than one week.
Finally, we also received chain-store sales for June, which is the growth retail stores open at least one year recorded. The figure for June came in at 4.3%. Naturally, the press and many economists are stating this growth as a one-month blip due to the rebate checks.First, aren’t these the same people that tried to tell us just how glorious one-time rebate checks are. In reality, they’re a joke compared to the fundamentally sound nature of across-the-board tax cuts that affect behavior in a meaningful way and actually lead to job growth as small business makes up 65%-70% of those within the top federal tax bracket.
Second, the growth we’re seeing on the retail side of things is not a one-month blip at all as this is the third-straight month of nice gains. April same-store sales rose 3.5%; May was up 2.9%; and June we already mentioned as up 4.3%. As we’ve noticed over the past few years, the press says just about anything they like – and let’s be laconic -- a lot of it is mendacity on parade.
Have a great weekend!
Brent Vondera, Senior Analyst
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