Daily Insight

U.S. stocks gained for a second-straight day – up four of the past five sessions – as oil has dropped to a 14-week low, boosting shares in most major industry groups. Consumer discretionary and financial shares led yesterday’s increase. Energy and material shares were the only decliners among the S&P 500’s 10 industry groups. The S&P 500 Energy Index has dropped 20% from its May 20 all-time high.

What has occurred in oil and the dollar since I’ve been out has been pretty amazing and welcome. I’m contemplating taking about six months off – at this pace oil would be down to $10 per barrel, the Dollar Index would hit 100 and even stocks would be higher by 10%. Although at this rate, six months from now Russia would have regained control of the Caucuses and all of Eastern Europe.

Market Activity for August 11, 2008
The decline in oil prices has been very welcome, as we’ll touch on more specifically below. It’s almost hilarious to watch this stuff as the press and energy-industry analysts now talk in terms that make one feel there are no risks that can push prices higher again. For instance, the IEA – International Energy Agency – is now saying that supply will be more than sufficient to meet demand; this is with an increase in their 2009 demand forecast. This is the opposite of what we have heard over the past several weeks as these agencies were stating supply was inadequate. And oil continues to move lower even with the Russia/Georgia conflict and the uncertainties this brings regarding the Caspian pipeline.

Over the past eight trading sessions market activity has continued along its whipsaw path. The first three days of my absence the broad market was down 2.76%; it more than erased those losses jumping 3.21% last Tuesday and Wednesday; gave much of that back on Thursday, but following Friday’s big day, helped by yesterday’s rise has put us up 1.6% since the July 30 close.


We were without an economic release yesterday, so I thought it may be helpful to touch on the economic highlights since I’ve been out. David likely touched on many of these points already, but it is worth reviewing this stuff.

Second Quarter GDP

The economy grew at a 1.9% real annual rate.

The additions to growth were:
Personal consumption (although it added less than what I was looking for as higher inflation reduced real consumption. CPI rose at a 7.4% annual pace in the second quarter.)

Exports provided a large boost, but the degree to which it helped was not from export activity alone but net exports, which jumped due to a decline in real imports – import prices have soared, reaching 20% year-over-year as of the latest data.

The drags on GDP were:

Housing subtracted from growth for the 10th straight quarter, but the decline was much less than it has been averaging. Residential fixed investment declined at a 15% annual rate March-June, much less than the 27% annual rate of the previous quarter. Maybe a portent of good things to come; we shall see.

The change in inventories weighed heavily on the figure. Although, if something is going to weigh on growth, let it be this. Stockpiles are very low and firms will have to increase production, which will keep growth positive in the coming quarters. Friday’s wholesale inventories figure continues to illustrate this fact. Sales continue to rise, jumping 2.8% in June driving the inventory-to-sales ratio to an all-time low.

July Jobs

The labor market remains weak as July marked the seventh month of decline. However, the level of losses remains relatively low compared to normal job-market downturns. Construction and business services continue to weigh on the figure; education and health-care continue to be the bright spots. Youth unemployment also continues to drag the figure lower.

June Factory Orders

This was the best release of the past week-and-a-half. The figure jumped 1.7% for the month and continues to indicate good business spending trends are upon us.
New orders were up for the fourth-straight month; shipments up six months straight (up 1.6% in June to $454.6 billion, the highest since the series began in 1992.)
Unfilled orders up for 28 of the past 29 months to the highest level since the series began.

Non-defense capital spending (a proxy for business spending) was up a strong 1.2% in June. I’ve got to think GDP will be revised higher due to the combination of this data and the June inventory number (which was higher than estimated) -- the May figure was revised higher as well.

The biggest news of all of the past several trading days was undoubtedly the Fed statement and what oil and the dollar have done.

First the Fed

What is going on appears to be an attempt at a “garrulous” form of tightening. That is they are talking tough, but doing nothing even as the inflation gauges rage past the FOMC’s desired levels and they even admit the state of inflation is “highly uncertain.”

The FOMC (for new readers that may not know, this is the committee that determines policy) statement can always be summed up in three paragraphs: Growth, Inflation and Future Stance. The Fed continues to worry about economic growth and credit-market functioning, but has become quite worried about inflation too. Problem is when the FOMC states that inflation is “highly uncertain,” yet they do not raise rates – even mildly – it becomes worrisome. That term “highly uncertain” may be signaling a slight increase in rates quicker than most seem to expect, I may be alone on this thought.

(Look, I realize that it doesn’t make sense to jack rates higher due to credit-market and financial institution issues, but those talking about such action desire a gentle increase. The longer they wait, as inflation becomes embedded, the greater the likelihood they will have to jack rates up to a point that does major economic damage. And there is evidence that price increases are becoming embedded, as the most watched small-business survey along with the ISM and PMI indices show this is occurring.)

Again, as we’ve discussed many times, the Fed does not have a magic wand. There is not much they can do about housing – only time can reverse the excesses of 2005-2006. But they can determine the direction of inflation and it is problematic that they have abandoned price stability as we have been left with both the housing correction and higher levels of inflation.

Now on oil and the dollar

What has occurred here has been huge and is giving Bernanke & Co. some cover -- not that they needed it though, they didn’t seem too eager to quash inflation as oil jumped to $145 per barrel and the dollar was in the dirt, down to 71 on the Dollar Index. In fact, I think they could have pushed oil down to $100 with a 25 basis point cut – hammer it when it’s down.

For now though crude has come down on some very good comments out of Congress – pushed by President Bush – leading the market to believe just maybe drilling restrictions will be removed. This has combined with a reduction in government subsidies in Asian economies (subsidies that have kept demand higher than it otherwise would have been at these price levels.)

It’s tough to read on the chart, but oil is down 7.5% since July 30. Crude has plummeted 22% from the all-time closing high of $145.29 hit on July 3.


On the dollar, I continue to believe it will take some Fed tightening to get us back to 80 on the Dollar Index (a level that is necessary to get us out of the danger zone regarding the greenback) but things have certainly moved in the right direction.


Some of this move has been due to the realization that the Eurozone is weakening and thus a super-strong euro makes zero sense – so traders have moved back to the dollar.

For now though the oil/greenback move is huge. The higher dollar will help ease pernicious import price trends and oil now down 22% from its high will benefit the consumer, GDP, stocks, real income growth and the inflation gauges to some extent if this holds. Huge development.

Have a great day!

Brent Vondera, Senior Analyst