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Well, it's been crazy. Good news is bad news, bad news is good news. Many counter-intuitive moves in the market. In times like these I find it;s best to step back, reassess and try to find some anchors. For only with strong conviction can you ride out the short term swings. Some anchors or truths are:
- Gas prices are going to stay high. Even if Rita does minimal damage, we have enough production closed to keep things tight for some time.
- Budget deficits are going to grow significantly.
- Corporate earnings are being impacted by higher energy prices. AA today is only the latest.
- Inflation is in the pipeline
- Fed tightening will continue.
The question is, do current prices reflect optimism or have they priced in the worst? One thing seems obvious, the market likes deficit spending. The increased fiscal spending, means and economic boost now, while payback is down the road. The budget deficit is going to be huge, but the market will worry about that later. Both politicians and corporate America live in a current quarter mentality. Nothing gets done without a crises, and planning does not look far ahead. Whatever happened to the Social Security crises.
The dollar has been strengthening lately. A German political crises has helped. The increased fiscal spending, which I have read could amount to 1 1/2% of GDP has provided even more support. With no fiscal discipline, the Fed has to continue tightening. As I've said many time before though, any economic weakness will quickly spill over to the buck. We could see the economy weakening despite the fiscal laggress because of the housing bubble bursting, the consumer being tapped out, higher rates, loss of confidence by foreigners in our financial markets.
The bonds will be important to watch over the next few months. Before this all started, we were already borrowing 80% of the worlds savings. Should their supply or preferences change where will the money come from? Even if we print it long rates will rise. Like the 70's we could have weak growth and higher inflation ahead.
The market has started to give back some gains it made, if you recall, first on Katrina not expected to be as bad as feared and then when it was actually worse, on the bump from rebuilding. The 40 pt rally in S&P is a perfect example of the old sayings, that the market can do anything, the market can stay irrational longer than you can stay solvent, the market cannot be predicted using rational means, etc. The rally looks like it was a bull trap, short and powerful. No volume on the downside yet, so they all got em. The market is supported by fiscal spending on Katrina, lower oil, and hope the Fed is done or close to it.The bonds are coming under pressure. Last week's manufacturing surveys showed very large increases in the inflation indexes. We have also had many companies start to raise prices as their energy costs increase. Oil prices are starting to pass through. If the Fed blinks they may be seen as falling behind the inflation curve. That of course would be very negative for bonds and the dollar as well.
The dollar keeps getting bailed out. First there was the failure of the referendum on the European constitution and now the deadlocked German elections. The talk is, we won't know the election results for weeks. Eventually it will recede from the headlines and since nothing has dramatically changed the dollar will resume its underlying downward move. It's a choice between the lesser of two evils.
Gold is reflecting slower growth, higher inflation, increased demand from China and India, and lower production. Back to the 70's.
You can see from the action of the bonds and the dollar today that the idea of the Fed blinking and not raising rates has reversed. Chicago Fed Pres helped that idea along with his midday comments where he voiced more concern over inflation. So it seems Greenspan will continue his mission to take away the punchbowl. I guess he wants to go out with his reputation as an inflation fighter intact. If they go ahead and raise rates, I think it will be the last time this year. Even the Treasury Secretary this morning acknowledged that the economy would slow. The political outcry that is already beginning will overwhelm the Fed's desire to raise rates if the economy fades.
A lot more news of higher spending today and higher costs. Higher transport costs from using alternate ports and methods of transportation and higher spending on everything from unemployment benefits surge to various relief expenditures. Not to mention lower tax revenues due to less people working and slowing economic activity.
- Yesterday was a low volume rally, only 1.42 B shares. Today's volume doesn't seem much better. Breadth was good.
- We are seeing a divergence between the S&P and the transports. Obviously this can go on for a while. It is not a timing tool but like volume it tells you something about the character of the advance.
- McDonalds is up over a dollar on a broker upgrade. I wrote about this stock a while back when it was under the influence of rumors on it spinning off its real estate. I thought that was highly unlikely and the stock started to come back down until it came under rumors about a spinoff of its Chipolte unit. While I think that is more likely, spinning off 435 restaurants out of 30,000 is not that big a deal. European sales are improving, but total sales have been slowing on a quarterly basis since the 1st qtr of 04.
- 1st 04 - 17.8%
- 2nd04 - 11.7%
- 3rd04 - 9.8%
- 4th04 - 10.3%
- 1st05 - 7.97%
- 2nd05 - 6.3%
- Doesn't look like the receipe for a 20% gainer since 7/7.
Maybe we should have a natural disaster more often. Stocks are higher now than a week before we ever heard of Katrina. The U.S. govt spending machine is revving up and that is what the market likes. We're going to spend another 100 billion we don't have and that means a pretty hefty boost to GDP in the short term. Destruction of wealth does not show up in GDP but replacing that destruction does. With Europe sending us some of their product reserves of oil over the next 30 days, that should keep oil prices relatively quiescent. Inventory numbers will be released Thursday and will probably show big draws so we will be able to see the price response then. Everyone is always eager to shout the good news, the bad news will dribble out.
Energy supplies will remain tight. We will remain short of refining capacity for some time to come. Oil is still $3 bucks a gallon and along with high natural gas prices will grind away at the consumer and the economy. Most of the government spending is going to security, housing, clean-up, repair etc. Relief spending does not increase productive capacity or profitability, regardless of how necessary it is.
It looks like we will start post Labor Day trading with a bounce. The market seems to be taking heart from lower oil and gas prices as a result of crude coming out of the SPR and products coming from IEA reserves. Also progress is finally being made in Louisiana. So the glass is half full at the moment.
The volatility in perception will continue for the next several months at least. The data will be lousy, but if you wish to view the glass as half full you can ignore it as temporary, due to Katrina. The bears will view it more ominoulsy of course, as undermining the fabric of economic growth. I continue to lean toward the bears and view this shock as one pushing and economy that was already slowing toward stall speed and a recession next year.
