Daily Insight

U.S. stocks gained ground Thursday despite a rough day on the economic front – and guess which sectors led the way? Yep, financials and consumer discretionary shares as has become the trend on days of strength. As we touched on yesterday, one can look at these two areas and based on their direction you pretty much know whether or not the benchmark indices advanced.

Ugly economic releases from the Labor Department sent the broad market lower at the open, but stocks quickly reversed course gaining nearly 2% from the session’s low – holding onto most of that rally to the close.

Market Activity for August 14, 2008
As financials (up 2.55%) and consumer discretionary (up 1.97%) led the way, most industries participated in the rally as seven of the 10 major S&P 500 groups rose. Information technology and industrial shares gained 0.70% and 0.56%, respectively. Consumer staples, health-care and telecom stocks advanced a bit as well.

The dollar continues to catch fire as evidenced by the Dollar Index, which has moved to the 77 handle. The greenback has jumped 7.30% in the past month – a huge move.


However, the 80 level in probably necessary to escape what many perceive as troublesome levels. I believe we need to see some mild Fed tightening in order to get there, but most seem to disagree with this view due to the credit/financial-sector woes. We shall see where the inflation gauges take us – more on this below.

In any event, it is good to see the greenback rally and it’s helping to push commodity prices lower from the highly pernicious move that took place in the three months ending June.


On the economic front, the Labor Department reported that initial jobless claims dropped 10,000 to 450,000 in the week ended August 9. While a decline is nice, the figure currently hangs at a worrisome range. The chart below shows the four-week average has jumped well above the 400k level – this does not bode well for the August jobs report. As we had discussed for several months, jobless benefit claims held below this 400k level, which gave us confidence the monthly job losses would remain mild. Now that this figure has spiked, it becomes much more difficult top remain sanguine that those losses will remain below 80,000 per month.

That said, due to the government’s Emergency Unemployment Compensation Program it will take a couple of weeks to get a truer reading on claims as a way to gauge the overall job market. (The BLS (Bureau of Labor Statistics) believes the impact of this program has peaked.)

Thirty-five states and territories reported an increase in claims, while 18 reported a decrease.

Continuing claims – those collecting benefits for more than a week – have risen to the highest level since October 2003. The recent government program to extend the length of time one can collect is helping to push this figure higher as those that would otherwise have seen benefits expire, can continue to take the handout.


In a separate report, the Labor Department reported the consumer price index rose 0.8% in July and accelerated on a year-over-year basis to 5.6% -- that’s the highest in nearly 18 years. On a three-month annualized basis the CPI has jumped 10.6%; that’s an acceleration from 7.9% during the previous three-month set.

I’ll note CPI is known to overstate inflation, yet the chained CPI figure – which tracks consumer preferences and the substitution effect more quickly – rose to 4.8% year-over-year after a readings of 4.2% in June and 3.6% in May. This means the Fed’s preferred inflation gauge, the PCE index – will hit roughly that level, which is considerably higher than Bernanke’s stated “comfort zone.”


Over the past few weeks we’ve mentioned the risk of inflation becoming embedded – that is, firms have gotten hammered with higher commodity costs for such a long time they have now begun to aggressively raise prices to compensate for those higher costs. The ISM and PMI (as most readers know these are factory activity indexes) business surveys have been showing this occurring of late; now we have the most-watched small business survey (from the National Federation of Independent Business – NFIB) report a record-high percentage of firms both raising prices and planning to do so in their latest August report.

People look at the lower energy prices of late and expect this to push future inflation gauges lower. I’m just not sure this will occur to the extent they are expecting due to the trends just mentioned. In addition, food prices are also boosting the inflation figures, so energy isn’t the sole reason. On the bright side, the medical care reading within CPI has been nicely contained over the past several weeks and decelerating -- up just 0.1% in July.

There is one group that can essentially make sure the inflation trend does moderate and that is the Fed. Just some mild tightening could go a long way. Yes, this will hurt mortgage resets, but many of these people are in a world of hurt anyway – fed funds could be cut to 1.00% and those that couldn’t afford the initial interest rate on their adjustable mortgage will still find they’re in a bad spot. Besides, those that put little-to-no money down now find their loans are higher than the house is worth. And further, yes, banks need to raise capital and the Fed’s easy policy has this in mind also. But it is a very dangerous game to abandon price stability. Besides, let’s not put undue harm on the entire economy just to help out those that have made poor decisions.

In other news, I see the Europeans have been mugged by reality as the Russians continue to push into the interior of Georgia, well past Ossetia. The Germans had been blocking Eastern European membership to NATO. Now that it has become obvious Russia’s aim is to control the Baku-Tbilisi-Ceyhan pipeline – the only oil flow in the region that Russian does not have control over – and thus block energy to Western Europe, while attempting to dictate Eastern Europe’s future, the Euros seem to be coming around. This is an important and very positive development even if Russia’s actions are troubling.

Have a great weekend!


Brent Vondera, Senior Analyst

Daily Insight

U.S. benchmark indices declined for a second day – led by what else? financial and consumer discretionary shares. These have been the stocks that either push the major bourses higher during rallies or pressure the benchmarks on days of decline as questions over the housing market and consumer are the lead worries. (For the market in total, certainly inflation, tax rate, dollar/oil and geopolitical event uncertainties all currently weigh on investor sentiment. But regarding GDP components, it is housing and the consumer and so long as this is the case financials and consumer discretionary will determine the market’s direction.

The broad market did improve as the day wore on (as the chart below illustrates) thanks to core retail sales growth and business inventories and sales data that indicate the economy is not as weak as many portray. A higher revision to GDP has been our theme for a couple of days now as that’s what the data of the past few days is telling us. The mid and small-cap stock indices bucked the trend to advance yesterday.


Market Activity for August 13, 2008

The best performers of the day were energy, basic material, utility and information technology shares. Energy stocks received a boost, after four-straight sessions of decline, as oil rose 2.65% to $116 per barrel. The weekly energy report showed a larger-than-expected decline in supplies – which was probably a result of Tropical Storm Edouard as it caused rigs to suspend production and halted imports for a couple of days.

On the economic front, overall July retail sales fell for the first time in five months due to weak auto sales – the figure declined 0.1%. Excluding autos, sales rose 0.4% last month and have jumped 10.3% at an annual rate the past three months.

Core retail sales, which exclude autos, gas station receipts and building materials, rose 0.3% in July and are up 10.2% annualized the past three months.

The relevance of this core reading is two-fold:

One looking at this figure minus gas station receipts during a time of high prices helps to reduce the impact of a boost in this figure due to those high prices. Further, subtracting building materials has helped to smooth the data and remove the volatility of a housing market that was boosting the reading to robust levels during the peak of the housing boom that ran 2005-2006 and subtracts from the figure due to the housing correction currently.

Second, this core retail figure is used to calculate the consumer spending portion of GDP – since this reading has advanced at a pace that outpaced inflation during the quarter (thus real consumer consumption was higher) it provides yet another indication Q2 GDP will be revised higher.

In a separate report, the Labor Department reported that import prices jumped 1.7% in July and has accelerated to 21.6% year-over-year. Even excluding oil the figure remains high, up 0.9% in July and 8% from this time last year. The dollar/oil trend of the past few weeks will help to improve this, but we’ll need to see oil and the greenback continue to trend in the desired direction or at least hold here.


Lastly, the Commerce Department released its June business sales and inventory reading. This figure also illustrates GDP will be revised higher. Putting the trade (as discussed yesterday), business inventories and core retail sales data together – all figures that were stronger than initially estimated when the first look at GDP was released – we’re looking at a real rate of growth of at least 2.5% and may be close to 2.8%. That’s not bad considering housing’s drag on the economy. (For context, our long-term average is real annual growth of 3.4%, or roughly 6.5% in nominal terms.)

Anyway, business inventories rose 0.7% in June, beating the expectation of a 0.5% increase. Sales growth was powerful again, jumping 1.7% in June -- up 17% annualized past three months and up 9.2% year-over-year.

I’ll caution, since we’ve had four straight months of robust sales data (up 1.2% in March, 1.5% in April, 1.1% in May and now this big 1.7% increase), July will probably show a natural decline. The economy is weaker-than-normal and this pace will not be sustained. Nothing wrong with that, I’m just preparing everyone for the media hysteria that arises when the number posts a decline as these people are unwilling to put things into perspective.



This morning we get the CPI figure for July and initial jobless claims. Both will be closely watched, but the market will probably focus a bit more on the jobless claims number since it has moved higher over the past two weeks and is showing an ugly trend. The CPI reading looks ugly too but the recent decline in energy prices has eased the inflation worry a bit – for most at least.

Have a great day!


Brent Vondera, Senior Analyst

Daily Insight

U.S. benchmark stock indices declined yesterday, pushed lower by financials shares after JP Morgan warned it may post more credit losses – not sure this was really news as most expect financial losses to drag on for at least another quarter, but there just wasn’t much else to trade on so the market focuses on this negative.

Also putting pressure on bank stocks were comments from Dallas Fed Bank President Richard Fischer who mentioned the current financial turmoil is worse than the savings and loan crisis of the late 1980s/early 1990s. I’m not sure about that one, especially since William Seidman (former chairman of the Resolution Trust Corporation, which was instrumental in cleaning up that mess) has gone on record saying the two are not comparable. But, we shall see. For now, not surprisingly, these types of comments will be met with market downside.

Market Activity for August 12, 2008

As said, financials led things lower as the S&P 500 Financial Index lost 5.19%. Utility and consumer discretionary shares were the other major losers down 2.08% and 1.48%, respectively.

Consumer staples and basic materials were the only two major industry groups to post gains. Commodity prices fell some more yesterday but the declines leveled off, offering some support to the materials stocks – these shares have taken a beating over the past few weeks. The CRB (Commodity Research Bureau) Index has dropped 18.8% from the July 2 high.


On the greenback, the dollar continues to strengthen, which is nice and is a development that was very much needed regarding international-investor perceptions and inflation – particularly with regard to import prices. As we touched on yesterday, I think we’ll need a little Fed tightening to get us to 80 on the Dollar Index – a level that will make those worried about the greenback much more comfortable. For now though, at least we’ve returned to where we were in February and have erased the most recent leg lower.


On the economic data front yesterday, the Commerce Department reported the trade deficit narrowed in June, which was an unexpected move as the estimate was for the figure to widen – although I’m not sure why the narrowing was a surprise as import activity has been lagging export growth for many months now. Nothing of late has shown this trend will end in the immediate future.

Exports rose 4% as imports were up 1.8%. The importance of this narrowing is it will result in a higher revision to second-quarter GDP (the initial estimate to Q2 growth assumed the deficit widened in June). Combine this fact with higher inventory and capital expenditure (capex) figures and we may just see that 2.6%-3.0% real GDP reading we expected a couple of weeks back.

But back to the trade figures for a moment, in real terms (adjusting for inflation) the trade gap narrowed sharply (to its lowest level since December 2001) as real imports declined 0.6%.

U.S. exports have been on fire fueled by sales to South America and OPEC countries. Exports to OPEC countries has jumped 33.7% on a year-over-year basis. I mention this to point out the fact that higher oil prices are not a zero sum game as this flows back in higher export activity.

These comments have in mind all of those that speak of importing oil as a wealth transfer – as if these funds are lost forever. Those that speak of wealth transfers due to trade fail to tell the entire story and are often times either oblivious to how the global economy works or intellectually dishonest. A large degree of the U.S. dollars that move overseas in exchange for goods come back to us in the form of investment. (Before I go on, make no mistake – I do not enjoy being more dependent than needs to be the case on certain regions of the globe for our energy needs. In my world, congressionally built barriers to domestic energy production would be torn down never to be rebuilt. In the end we will accomplish this simply because we’ll have to. The state of the world will marginalize those that believe producing our own abundant sources of energy is a bad thing – a mindboggling stance.

But back to the flow of capital, a large part of it comes back in the form of investment. Some goes to the Treasury market, simply because this is the most liquid and broad market in the world. A significant degree of it though also goes to corporate bonds, equities, mortgage-backed securities, and venture capital. I’ll remind everyone that our long-run return on capital is higher than our cost of capital. Hence, those funds finance future growth, which creates jobs, provides the seed money for innovation and technological advances and leads to higher levels of income growth -- higher levels of productivity, improved living standards, lower inflation and real economic growth are the by-products.

In other news, the Treasury Department reported the July budget deficit widened due to the rebate checks and increased outlays to the FDIC to cover insured deposits at failed backs. The $102.8 billion deficit last month compared to the $36.4 billion in July 2007. Lower tax revenues due to job losses and lower corporate profits – mostly a result of financial-sector woes – has also increased the deficit, but the real damage has come from this Keynesian rebate check scheme.

Too bad because last year we had whittled the budget gap down to just 1.2% of GDP – half the long-term average. This year will be a different story, however. Nevertheless, the deficit will remain manageable for now, but if we do not get a handle on entitlement spending and reform these programs to reflect changing demographics we’ll have a problem on our hands a few years forward.

On the bright side, corporate tax receipts rose 6.6% in July on a year-over-year basis. This marks the first increase in a year.

This morning we get some very important data as July import prices and retail sales will be market movers. Also we get the June business inventories report, which should show the estimated inventory change that dragged so heavily on GDP was flawed. A larger-than-expected reading here will provide additional evidence Q2 GDP will be revised h

Have a great day!


Brent Vondera, Senior Analyst

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

Daily Insight

The roller-coaster ride continued with the Dow posting its second 300-point move of the week and the sixth move of at least 200 points in the last 10 trading days. Meanwhile the S&P 500 jumped 30.25 points higher to finish the week 2.9 percent higher.

Oil futures slid 4 percent to a three-month low of $115.20 a barrel due to expectations of curbing demand and a sharp rebound in the dollar. After tumbling 7.9 percent this week, oil is nearly 21 percent off its early-July highs.

Retailers, manufacturers and transportation companies rallied the most on speculation lower commodity prices will boost profits by reducing pressure on consumer and corporate expenses.

Market Activity for August 8, 2008

Coinciding with tumbling oil prices was a surging dollar that enjoyed its best one-day performance in more than six years. However, the dollar’s rise against the euro may have less to do with the currency’s fundamental strength than the growing feeling that the European Central Bank will focus their attention to the downside risks to growth.

The dollar was also helped by news that worker productivity in the U.S. grew in the second quarter giving investors (and the Fed) positive encouragement on the inflation front.

While three-quarters of S&P 500 companies have reported results that beat or met the average analyst estimates, the misses have been larger in size, chiefly at automobile companies and consumer finance companies. Despite being the worst performing of the S&P 500’s 10 industries, financial and consumer discretionary stocks have led the market’s rebound since July 15 gaining 25 percent and 13 percent, respectively.

There are a number of things to watch this week to see if we can continue this rally.

• Economic data on retail sales as well as earnings this week from retailers like Walmart, J.C. Penny, Kohl’s and Nordstrom should give us an idea of how the good ole U.S. consumer is doing.


• Wednesday we will get the MBA Mortgage Applications number as well as guidance from homebuilder Toll Brothers, which will give us insight into the housing environment.


• One of the most important numbers this week for the Fed will be the Consumer Price Index (CPI), which surged last month signaling the downside risks of inflation may outweigh the downside risks to growth.


• Other economic news to keep an eye on includes import prices, industrial production and jobless claims.

Brent will be back tomorrow to grace you with his words of wisdom once again.


Have a great day!

Peter Lazaroff, Junior Analyst