Enter your email address:
Delivered by FeedBurner
Got whiplash yet? If not, stand by because volatility is rising and seems likely to get worse in the months ahead. The S&P 500 was up 0.1% last week but that masks the volatility of the week. Stocks were down 1.6% Tuesday and up 1.7% on Thursday after a good jobless claims report (see below). Friday gave back a big part of Thursday’s move although a late day rally made things look a bit better heading into the weekend. The problem, as everyone no doubt knows, is oil prices and while a calmer Middle East would help on that front, it isn’t the real source of the problem. That would be the weak dollar which is balanced on a knife’s edge right now. It is noteworthy that the dollar hasn’t been able to gain during this crisis as it has in so many others recently. The dollar is falling against damn near everything right now from gold to the Euro. You know your economy has problems when your currency is falling against the Mexican Peso.
If this were a normal recovery, I’d be raging bullish right now. The economic statistics continue to improve and some of the ones that have served me best in the past are now looking quite good. The ISM surveys are hitting near all time highs. Jobless claims are solidly under the 400k level and approaching the “normal” zone. The problem is that this isn’t a normal recovery and unless we get better macro policies soon, I don’t think it will turn into one. The Fed’s inflationary policies are not a free lunch and the costs are rising every day. I don’t know what price of oil tips the US back into recession but it can’t be that much higher. Whatever stimulus we might have gotten from a higher stock market has surely been offset already by rising food and fuel prices.
How long can the Fed ignore rising commodity prices, especially oil? The ECB is already hinting - loudly - at a rate hike and much of the developing world is already tightening policy. Maintaining zero interest rates in the face of a rising and obvious inflation problem just makes a weak dollar that much less attractive when compared with the alternatives. I’m sure the Fed would like to wait for better fiscal policy before starting on a tightening cycle but based on the current political haggling over a mere $60 billion in spending cuts - in the face of a $1.6 trillion deficit - it seems unlikely they will be able to wait that long. And waiting too long has a very high price. If rising oil prices push the US back into recession, there is very little the Fed can do. Our problems are fiscal and monetary policy can’t solve them.
In case you haven’t noticed, I have become increasingly bearish over the last couple of months. The recent improvement in the economic statistics isn’t enough to change my cautious stance. Stocks are not cheap, dividend yields are near all time lows and bond yields are not enticing. Junk bonds pay more and have performed spectacularly but you sure don’t want to own them going into a recession. Ditto for floating rate funds that have become so popular recently. The dollar is cheap but the alternatives - except for gold - all have their own problems. The Euro has been rising but the debt crisis there seems far from over. The emerging market currencies only seem attractive as long as they maintain their growth rates which would be difficult or impossible if the US economy rolls over. Cash is not an asset I enjoy holding but it seems the best place to hide until there is more clarity about future policy. Hold onto your hat; the ride is about to get a lot bumpier.
The economic headlines last week were generally positive but the details a bit less so. A lot of the good news came from the manufacturing sector which has been leading from the beginning of this recovery. Housing and construction data released was exactly what we’ve come to expect - still pretty bleak. The employment situation continues to improve but it’s slow going and it is disconcerting to see employment remain so weak when other indicators are at historic peaks. The worst news though concerns inflation which is raising costs for a wide variety of businesses.
The ISM surveys last week confirmed that growth in both the manufacturing and non manufacturing sectors is still accelerating. The manufacturing version, along with the Chicago PMI also released last week, was particularly strong with the only negative being a continue rise in input prices. The employment component rose 3 points to 64.5, the highest since the early 70s. New orders, export orders, backlog orders and a lengthening of delivery times all point to strength. The rise in prices is - or at least should be - a source of major concern. The Fed’s weak dollar policy is wreaking havoc with commodity prices. Some comments from survey respondents:
“A continue weak dollar is increasing the cost of components purchased overseas. It is going to force us to increase our selling prices to our customers.” (Transportation Equipment)
“We continue to see significant inflation across nearly every type of chemical raw material we purchase.” (Chemical Products)
It is interesting that while every commodity listed was reported to rise in price there were only a few reported in short supply. That tells me the price rises are due to the falling dollar and not just a function of supply and demand fundamentals. Companies faced with rising costs are increasingly passing it along to their customers too. From the Fed’s Beige Book report last week:
“Non-wage input costs increased for manufacturers and retailers in most Districts. Manufacturers, in a number of Districts reported having greater ability to pass through higher input costs to customers. Retailers in some Districts mentioned they had implemented price increases or were anticipating such action in the next few months. . . . Most reporting Districts noted continued strong agricultural commodity prices.”
What companies aren’t able to pass along to customers will be wrung from other costs to keep profit margins up. Productivity rose 2.6% in the fourth quarter while unit labor costs fell by 0.6%. Falling unit labor costs should eventually translate into more jobs but with large companies sitting on plenty of cash and capital spending still rather punk, there is plenty of room for companies to raise productivity. In addition, accelerated depreciation for capital spending this year increases the incentive to use capital over labor. Commodity inflation just puts further pressure on companies to squeeze more out of their existing work force.
For those who do have jobs, income continues to rise. Personal income rose rose 1% in January for a 4.6% year over year gain. As stated above though the details were less inspiring. Income was boosted by reduced employee contributions for Social Security that were part of the tax deal late last year. Disposable income was also affected by the expiration of the Making Work Pay provisions of the “Stimulus” package. Excluding both those factors, DPI was up only 0.1%. Another negative was a rise in social insurance payments by employers. Taxes for unemployment insurance at the state level rose $7.5 billion making it more expensive to hire.
Personal spending was up a mere 0.2% and even that overstates the case. Rising gas prices increased consumption but what goes in the gas tank doesn’t get spent elsewhere. Chained dollar purchases were down 0.1% on the month. Rising headline inflation also makes consumers hesitant to spend on non essentials and that was reflected in a higher savings rate, up to 5.8%. It also further confirms as well that these temporary tax cuts do not increase consumption as their advocates claim. It is ironic in a way that politicians attempts to raise consumption keeps resulting in more savings. Those of us who argued last year that the payroll tax cut should have been on the employer side are being proven right. The cuts aren’t being spent on consumption (as if we needed more anyway) and business costs are rising.
Pending home sales were down 2.8% in December which confirms what we already knew. Rising mortgage rates are starting to reduce activity that is already reduced because of falling prices and high unemployment. Construction spending in January was down 0.7% and 5.9% year over year. The drop was due to a drop in private non residential spending (-6.9%) while private residential construction actually rose (5.3%). Construction jobs actually rose in the employment report last Friday so maybe this is just about over but if it is, I wouldn’t expect a boom anytime soon.
The employment news whipsawed the market last week. Thursday’s drop in jobless claims to 368k kicked off a nearly 200 point rally in the Dow while Friday’s jobs report shaved nearly 100 off the gain. The drop in jobless claims is good news and now brings claims down to levels associated with good growth in payrolls. It wasn’t soon enough to affect the employment report released Friday but it was still pretty darn good. A lot of people concentrated on the earnings numbers which showed no gain but overall the report was solid. Private payrolls rose 222k while government lost 30k. The household report was even better showing a gain of 250k in employed and a 190k drop in the unemployed.
The economy continues to improve slowly but inflation is a rising headwind that could easily change that to deteriorating slowly. It seems obvious to this observer that the Fed is just creating new problems rather than solving the old ones. Their policies are raising inflation and inflation expectations as they intended. One wonders when they’ll figure out that adding inflation to our list of worries about the US economy was a mistake of epic proportions.
If you'd like to receive this free weekly commentary by email, Click Here.
Weekly Chart Review, Click Here.
“You know your economy has problems when your currency is falling against the Mexican Peso.”
Classic.
Name (required)
Mail (will not be published) (required)
Website
XHTML: You can use these tags: <a href="" title=""> <abbr title=""> <acronym title=""> <b> <blockquote cite=""> <cite> <code> <del datetime=""> <em> <i> <q cite=""> <strike> <strong>
« Devaluing the Dollar Will Not Reduce the Trade Deficit
Contrarian Musings is © 2008 Alhambra Investment Partners LLC. All rights reserved. Please read our Terms of Use and Privacy Policy.
Read Full Article »