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On Aug 19, I said "We have had our first small whiff of possible economic slowdown and the buck was non-plussed. When the market gets stronger evidence of this possibility and starts to look forward to the day the Fed blinks, put a fork in it, the dollar rally is done.". Well, I think we are there. The fallout from hurricane Katrina will slow the economy. This will reduce the growth differential between us and Europe and stop the interest rate difference from widening further. Yes this will slow global growth but Europe will be seen as being less leveraged than the U.S. and of course they are not pursuing a Mideast war that is going badly. Can you imagine what our trade deficit is going to look like.
A weakening dollar and high oil prices should also be bullish for gold. I worry about gold stocks though, because they use so much energy in their operations and the gold price has not gone anywhere since year-end while oil is up 65%. Their margins are getting crushed.
The S&P topped out at 1246. If it could have made it to 1253, that would have been a .618 retracement from the 3/24/00 high of 1553 and the 10/10/02 of 768. Close enough for me . Take a look at a weekly chart and you can see this may have just begun.
Finally, the law of unintended consequences is at work. The ramifications of the hurricane and our responses have just barely been scratched. This will be a story with staying power.
Their will be negative news flow from these consequences for some time.
Throw out yesterday because the range was so narrow and stocks have finished near the lows of the day for 7 days running. I wonder when the last time that occurred? Ever since Walmart said gas is affecting sales 8/16, we have been in a funk. The homebuilders, retailers and banks are taking the brunt. We have rolled over. How far and how fast do we go. Think about this. Short term CD rates, 6mth, are almost 4%. That's beat a lot of asset classes lately, RISK FREE! I mean stocks, gold, bonds, etc have been mostly sideways. With all the uncertainty over oil prices effect on asset values and all bubble talk over real estate, these kind of short rates are going to start draining liquidity out of risk assets. In three weeks the Feds going to give you another 1/4%.
The CEO of DRD gold commented that the oil/gold ratio was at historical lows and had a long way to go up to catch up. That can be said just about everything. The price of oil is outstripping everything, and either prices rise or profits fall, particularly amongst heavy energy users like airlines, mining and chemicals to name a few. It doesn't look like prices are rising.
The bond market has retraced about 1/2 of it's losses from July highs to August lows. This is where the rubber meets the road. The yield curve shouldn't flatten any further especially after hawkish statements by the Chicago Fed Prez yesterday, unless the economy is really rolling over, which may well be the case. But one would think that we would really have a battle here for days if not weeks.
Pre opening it looks like stocks could get a bounce today. They are oversold. The hurricane looks like it will miss oil installations so crude is of its highs. But if your going to play the rallies in this type of environment, remember they are most likely going to be sharp and short.
You can almost feel the consensus build on CNBC one by one that oil is finally going to hurt the economy and markets. I might go one further and say its baked in the cake. Past price increases are now working their way through the economy and profit chains and we will see negative news flow continue to grind away. Local news yesterday reporting on the impact on local governments that operate huge fleets of school buses bracing for huge budget shortfalls as a consequence of higher gas. Isn't school just about to start
It is amazing how quickly the perspective on oil has changed. It was only 2yrs ago that oil was trading at $30 a barrel midway between its decade range of $20-40. That's when OPEC was concerned about losing market share, limiting production output, afraid of high prices causing a drop in demand, concern over alternative fuels etc. Today an analyst on CNBC is concerned over Venezuela or Iran withholding a measly hundred thousand barrels of oil for political purposes. To punish the U.S. and display their power, which they could easily do as they are awash in oil riches. It almost seems like any place that produces the stuff has potential geo political issues so that we will never return to the placid world we knew before. As I've said before price will ration supply
Is it me or does the market feel really really heavy. About week ago I wrote about the correlation between strong stock closings with strong bond closings with oil having little influence. The past 5 trading sessions has seen a complete reversal of that correlation. For the past 4 trading sessions bonds have closed near the highs of their daily range while stocks near the low of their daily range. More importantly, every trading session since Walmart reported earnings 8/16 and said they were concerned about gas prices hurting sales, stocks have closed at low end of the trading range for the day. Bonds started their rally shortly thereafter
. Data showing the housing boom may be slowing hurt the homebuilders that even the bond rally couldn't help. To ice the cake, a couple days after the Walmart news, oil after trading as low as $62.25 started moving back up dashing hopes of an intermediate correction.
So here we sit. Our leadership of retail and homebuilders has rolled over, oil is close to threatening the highs again. Google the poster child of the bulls, may be rolling over. It will be interesting to see if their news today about introducing instant messaging lifts the shares back over $300 the next few days. Anecdotal stories about higher gas prices inflicting pain are now every where and multiplying. Airlines are getting killed, farmers are getting hurt, delivery companies, big energy users off all types and stripes. It's becoming the lead story on the evening news and that can't be good for confidence. The worst month for the market is around the corner and the big boys will be back from vacation soon.
Yesterday's low in oil $62.25 was 8/1 high. So we are basically unch in oil for the month. Bond yields on the other hand, after falling most of the month have rallied over the past few days and are lower around the 4.20 level from 4.30 at the start of the month. So why is the S&P 20 pts lower. The DOW by the way has fared better, as a series of individual stories helped propel individual stocks. We had the MCD rumors of a real estate play. MO got a favorable court ruling, HPQ reported good earnings and popped $3 bucks. I think higher gas prices and WMT's warning have spooked the market. No knockout blow has been delivered by either bull or bear, but we are starting to tilt lower.
The bond rallied as oil prices hit $67 indicating the vigilantes do not see inflation and are more concerned about a consequent economic slowdown. Each major bond rally has been accompanied by a spike in refi's that kept the economy going. But each refi spike has been smaller than the last. The psychological effect of these gas prices may curtail refis even more this time, even if the bonds continue their economic weakness rally in the face of Fed tightening. The consumer may flinch about borrowing more. Then we will have arrived at the proverbial pushing on a string.
The dollar has had a nice rally this week on the back of data showing greater inflow of funds into Treasuries from abroad and the outlook for further Fed tightening continuing to add to our yield advantage. We have had our first small whiff of possible economic slowdown and the buck was non plussed. When the market gets stronger evidence of this possibility and starts to look forward to the day the Fed blinks, put a fork in it the dollar rally is done.
An interesting correlation last week, well actually since 8/2, is that every day the bond market closed near the high of its range for the day, so did stocks, regardless of what oil prices did. The opposite was true as well. Every day bonds closed near their lows of the range of the day, so did stocks, even if oil fell like it did 8/4. So oil didn't matter or its rise was compensated for by lower interest rates. Friday, however stocks closed neutral, about the middle of their range for the day, even though bonds had a big rally and finished strong. Oil might finally be exerting some influence as it broke the $67 barrier with fears of $70 around the corner. Inflation measures this week and gas pump prices will be negative, as will lingering concerns over tech stocks in light of DELL and CISCO. Earnings from retailers should be good, but it will be their guidance that matters most.
I don't usually comment a lot on individual stocks but the action in McDonald's last week, is to good to pass up. Rumors of a big REIT like Vornado buying a stake in the company to monetize it's real estate values sent the stock and its call options flying last week. MCD started to hit its lows in the spring of 2003, as same store sales were declining 4% a month. MCD had been a growth stock for decades and old management in an effort to keep that up started to diversify into other restaurant concepts in the late 90's as expansion opportunities waned and competition increased for their burger joints. That strategy failed, as their forays into other businesses never reached critical mass to contribute significantly to the bottom line and meanwhile tastes were changing as the population aged and they had their eye off the ball of their core business and it faltered. New management was brought in, cutoff all the expansion focused on the core business, introducing new menu items to cater to older and healthier tastes, extended store hours etc. Essentially pushing more product through existing distribution. It worked. Same store sales started to improve peaking at 13.9% growth in the spring of 2004. So from its low of around $14 a share in 2/03 the stock rallied to 34 1/2 in 3/05. But then same store sales started to settle down, as the comparisons grew more difficult and the stock pulled back to 27. June and July were better than April and May and so the stock bounced back a little to 31. The company itself is looking for mid single digit EPS growth. They fixed the business but are now in the same spot the old management was. How do you get growth out of a large, mature business going forward. They're already the biggest in every thing. They have the largest breakfast business, they expanded their menu, expanded their hours to get the late night crowd. By slowing international and domestic expansion and eschewing other restaurant concepts, they are back to being a one trick pony. Grow same store sales. This can be seen in the convergence of same store sales figures and total sales figures.
That brings us to the present. Up pops the rumor of Vornado, perhaps helped by the fact that they just recently raised some money in a secondary offering. Roughly 9m share at their current price, lets say 90 equals about 800M, sounds like a lot. Could it pop the stock $4? Sure, but consider this. MCD bought back 33M of its share in the last 6 months, approximately 1 billion dollars without much effect. Not to mention several analysts pointed out on Friday that MCD is not like Kmart. Though they have some nice parcels, most McDonald's are located on major streets next to gas stations and dry cleaners and the parcels are not that large if you are considering re-development. McDonald's picks their sites for a reason, so I don't think they want to go anywhere in the first place. Do they need the cash, that spinning them off in a REIT might provide. They have no major expansion plans, just the opposite.
Maybe someone should look into who benefited most from these rumors.
Since 6/27 the S&P has gone from 1190 to 1230, oil from 60 to 65 bond yields from 4% to 4.40% and fed funds from 3.25% to 3.5%. We might have hit a tipping point today. The reason I say this is that rising bond yields are finally starting to raise mortgage rates. Both the homebuilders and banks have rolled over. Oil at 65 will put pump prices at new records and finally influence consumer behavior. Gas prices always came back down in the past. New records will put that into question in consumer minds. 1253 is strong resistance and I thought we would challenge it at least once. We still might if something caused a selloff in oil, but stop waiting for inventories to do it. In commodities, price leads inventories. To me, oil looks like its entering the final phase of a blowoff top. I would not venture a guess to where that top could be. Bull markets in commodities accelerate near the end of their movcs. Remember gold going to 850? It was moving $50 a day toward the end, or beans in the teens or nasdaq to 5000, you get the idea. Pick a top? Not me. It's just doing its job. With so much demand, price has to ration supply. The danger of course is that we can't seem to do anything about it and the price might break the economy. I know the Fed will ease, but this time it may finally be pushing on a string.
The market acts like it definitely wants to go up. Any slight pullback in oil is an excuse for a rally. Rising bond yeilds however, seem to stop it in its tracks. Something to be on the alert for is any sign of economic weakness might cause a bond rally which ironically might ignite stocks. Short banks, homebuilders, and retail and stay long the energy group.
Even though the interest rate spread continues to widen in the dollar's favor, it continues to weaken. Stronger economic fundamentals in Euroland and Japan are overriding the rate advantage. Gold and gold shares have gone along for the ride. Higher oil and commodities in general are also pulling gold along. If bond yeilds continue to rise, can this continue? Opinions welcome.
Stocks did creep higher as I suggested in my last post, until they ran into weaker retail sales and higher oil. Bonds continue to be short and although the dollar did not get to 118 euro, I was correct in thinking it was about time to short the dollar.
Oil stocks have been the undisputed leaders, followed by homebuilders and retailers. So it should be. We are after all a consumption based economy. Financial stocks are the biggest sector of the S&P, and they have lagged badly. The higher bond yields and oil prices hurt 3 out of the four sectors very badly. Homebuilders look like they have finally topped out helped along by prodigious selling by insiders of course. The flat yield curve is hurting net interest margins and so the banks stocks got hit. The BKX looks like its broken down. Retailer's also were sold, starting with Target, the subject of a bearish Barrons article. The group sports pretty high PEs for such large companies in such a mundane businesses. Over the long run their sales growth can't run ahead of GDP. Just ask WMT. That leaves the energy stocks, and at least today they can't lift the entire market by themselves.
A few recent indicators have also become troubling. Sentiment, as reflected in the number of weeks that bulls have outnumbered bears at 145 is approaching its record of 152 weeks. Mutual Fund cash levels are at historic lows. Real Estate as a percentage of GDP is at a historic high. Insider selling is very high. The breadth divergence between big and small stocks is very wide. The current acct deficit at 6 1/2% of GDP is in no mans land. None of these are very good timing indicators, but together they do paint a picture of caution. We can't all get out the door at the same time.
