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

2Q 2008 Participant Insights

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Daily Insight

U.S. stocks ended a pretty wild session in the black as investors pushed aside another day of speculation regarding the likelihood of an Israeli attack on Iran’s nuclear installations and higher oil prices to focus on better-than-expected manufacturing and construction spending reports.

Stocks gained some steam early in the session when the ISM (Institute for Supply Management) survey showed factory activity expanded in June, but gave it back quickly as oil prices jumped on the Middle East news. The Pentagon released a statement mid-day dismissing the news and oil prices pulled back; stocks gained ground as crude fell from the session’s highs.

(With all of this talk of a strike, and Israel’s military exercise last month preparing for what may be the inevitable, Iran is suddenly inviting the idea of talks over their nuclear activities. Of course, this is what Iran does; they act as though they are serious about keeping to their end of the bargain, while they buy time and continue to enrich uranium to weapons grade status. The Israeli’s understand this and prudently prepare for action considering the regime continues to makes statement such as “Israel will be wiped from the map.” The market is currently trying to assess the appropriate multiple due to this uncertainty, among others.)

Market Activity for July 1, 2008

The S&P 500, as the chart below illustrates, had been down as much as 1.5% from the opening price, but jumped nearly 2% from those lows to close the session meaningfully higher. Financial, consumer discretionary and energy shares led the broad-market’s advance. The Dow’s gain was propelled by shares of American Express, Proctor and Gamble, McDonalds and Wal-Mart.

Advancing stocks just about matched decliners on the NSYE. Some 1.58 billion shares traded on the Big Board, slightly more than the three-month daily average. For this July 4th holiday-shortened week, volume is usually much lower, but with the June jobs data release coming on Thursday, traders likely delayed vacation to be around for this all-important report.

On the economic front, the latest manufacturing report showed factory activity expanded in June, marking the first move above 50 (the level that divides expansion and contraction) since January. Even so, during the previous four months of contraction, the index was just barely below the line of expansion and no where near the level that indicates trouble.

The Chairman of the Institute for Supply Management explained in the report, as we’ve touched on in the past, that when the survey averages 50 it corresponds to roughly 2.8% real annualized GDP growth. During the second quarter ISM averaged 49.4, so we’re looking at a GDP reading of about 2.6% by this indication.

(I believe we will see a number in that range as increased capital goods shipments, higher personal consumption numbers and the production needed to rebuild low inventory levels will catalyze growth. Housing will continue to subtract a full percentage point from the reading; if housing were merely flat, GDP would come in at 3.5% for Q2, but this flattening will not take place until the supply of homes comes down significantly – which will probably take another year, hopefully.)

In a separate report, the Commerce Department reported that construction spending fell less-than-expected in May, declining by 0.4% -- the consensus estimate was for a 0.6% decline. The April reading was revised higher to show a 0.1% drop, after previously estimated at a 0.4% decline.

Two months of declines surely doesn’t give one a sense of full-flowing optimism, but considering the residential component – which makes up 40% of this reading – was down 1.6% in May (and off by 26.9% year-over-year) these mild declines are relatively good news. Strength came from lodging construction (up 2.6% for the month), schools (up 1.6%), power plants (up 1.5%) and manufacturing facilities (up 0.9%).

Lastly, the auto industry released its sales data for June, and the turn down of the past three months continues. But lower sales volumes are not the result of a lack of credit availability or even demand. Instead, according to the report, there is just too much supply of trucks and SUVS and not enough of what consumers currently desire during this period of high fuel prices – more fuel efficient vehicles.

Over the next several months manufacturers will undoubtedly ramp up production of the cars people want in this environment and unless something changes with regard to the job market – which is currently soft but not showing statistically significant declines – sales should rebound several months out.


Have a great day!

Brent Vondera, Senior Analyst

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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

Daily Insight

U.S. stocks fell on Friday, adding to Thursday’s rather large declines, even as the day’s economic data looked quite healthy. But the typical pessimistic tone related to those economic releases, which always seem to tell only part of the story (funny how it’s always a negative commentary), and another day of higher oil prices – as the Fed remains lost in the wilderness of their Keynesian textbooks – was too much for investors to bid the indices higher.

As a result of Friday’s nearly 1% decline on the Dow, the index has virtually moved to bear-market territory. The S&P 500 remains roughly 2% from bear-market levels – which are defined by falling 20% from the top. That top was reached on October 9. The graphs below illustrate was has occurred over the past two years, and specific to this discussion over the past nine months.

Market Activity for June 27, 2008

Today marks the final day of the third quarter and things aren’t looking real nice as the broad market is set to decline 3.4% for the past three months. The poor quarterly results are due to the worst June performance since 1930 – down 8% this month with the final session to go. We were off to such a good quarter too as April was up 4.75% and May add another 1.07%. But oil prices have proven to be too much for the market to handle. Sure, we have a soft labor market and the questions as to the duration of the housing correction, but let’s face it the job-market declines have been mild and housing has been baked in for a while. It’s mostly about the direction of energy prices at this point.

Crude-oil futures picked up another 60 cents on Friday, closing the session above $140 per barrel. Crude has jumped 2.2% thus far this morning, moving above $143. I simply don’t see this situation changing until the Fed gets a clue and begins to overtly signal, and then follow words with action, they will begin to raise rates. As we’ve touched on many times, they do not need to raise their benchmark fed funds rate much, just a gentle climb to 3.00% by year end. This will take the steam out of the oil trade and do some amazing things in terms of causing the inflation gauges to decelerate. (Remarkably, the consumer-level inflation indicators remain remarkably tame. This is not so for the producer price and import price gauges, which are through the roof and the worry is that these levels will eventually end up moving to the consumer level. But this has not yet occurred.)

But back to the Fed for a moment, their current decisions are causing traders to keep their long positions regarding the oil trade and have led others to move in as well. According to Bloomberg News, net long positions in New York oil contracts jumped 90.5%. Long positions had touched a five-week low a week earlier as many believed the Fed would make a strong statement that the rate-hiking campaign would begin at their August meeting. Now that another meeting has come and gone, and they were pathetically non-committal with regard to policy, the oil trade goes on.

In addition to all of that, we also have geopolitical concerns pushing oil futures higher this morning, as worries about Iran pick up. Still, I don’t think I’d want to be long oil futures right now. It is a matter of time before the Fed begins to raise rates, they’ll be forced to, and oil should come off big when they do. Geopolitical concerns will remain, but this is why one keeps an allocation to energy and the stocks that provide the equipment to the industry.

On the economic front, the Commerce Department reported that personal incomes shot up in June, jumping 1.9% and sending the year-over-year increase to 6.4%. But much of this was due to rebate checks and the government transfer payments that also went out but were not officially termed “rebate” checks.

During June, $48 billion of rebate checks were delivered so when we adjust for this one-off incomes rose 1.3% last month, still a huge reading. However, there was a purely Keynesian aspect to this “stimulus” program that resulted in people getting checks that were actually more than their actual federal income tax liabilities for 2007. Part of the program was to essentially eliminate the 10% bracket, that’s how they came up with the $600 rebate for most individuals and $1200 for most couples. But others got money as well – a handout is the appropriate term.

You see anyone with income of at least $3,000 in 2007 got at least $300, and since federal tax rates have been driven to zero for individuals making up to $10,000 and couples making up to $20,000, their checks amounted to more than they paid in taxes and those payments were termed “social benefit” outlays. Put all of this together and there were $176.5 billion in government payments that boosted the June income figures. Still, what the media failed to report was that even when you adjust for all of this, June incomes still rose $49 billion, resulting in a 0.4% pick up in incomes for the month. That’s a healthy reading.

I’ve expressed some concern over income growth, especially with energy prices pushing higher, but even when we adjust for the government handouts, June looked good.

Spending jumped 0.8% in June, and has been quite strong from three months now – up 6.8% at an annual rate --, bouncing back very nicely from the respite consumers took during the first couple months of the year. Interestingly, there was $226 billion in income last month when adding in the government handouts, but spending rose just $77.4 billion. Hence, the majority of the “stimulus” handouts were saved, or used to pay down debt.

Overall though, the income (adjusted for the government checks) and spending figures looked good in June and remain on a solid trajectory. Unfortunately, the pace at which energy prices are rising is impossible for income growth to match. In time, very near term in my opinion, the Fed will do its part and this will not be the worry it is today. Their action is belated, but they will be forced to raise as oil will not begin a downtrend until they do.

We’ve got a huge week regarding economic releases. Today we begin with the most important regional factory index – that being Chicago. Tomorrow we get the national reading, which should show manufacturing activity remains very close to expansion mode even as housing and auto-industry woes weigh on the figure. Construction spending for May will also be released on Tuesday. On Thursday we round out the holiday-shortened week with the all-important jobs data for June.

Have a great day!

Brent Vondera, Senior Analyst