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Today's WrapUp by Mike Hartman 03.01.2006 Mon Tue Wed Thu Fri Archive |
MARKETS TURN 180 DEGREES FROM YESTERDAY
Tuesday’s closing bell had stock prices sharply lower, bond prices higher, and the dollar lower versus most major currencies, but today is a different story. Yesterday we saw a great deal of data depicting weakness in the U.S. economy, but today we see continuing strength in consumer spending, increased business spending, and more strength than was expected in U.S. manufacturing. The anchor on CNBC asked the man on the floor of the NYSE if traders were reacting to higher oil inventories or the possibility of the Fed backing-off interest rate increases. His response was, “No, neither! The talk on the floor is the resilience of the stock market, as if nothing ever happened yesterday.”
Let’s have a brief review of some recent economic data, and then see what changed today. Going back to last Friday, we got the steepest decline in over five years for durable goods orders with a drop of 10.2% reported for January (much to do with Airbus taking business away from Boeing). Monday had new home sales down by 5.0% and Tuesday existing home sales were reported lower by 2.8%. Also yesterday, fourth quarter GDP was revised to show growth of 1.6% for the overall U.S. economy. Inventory growth and investment in software and equipment rose more than expected. In the big picture, the GDP report showed weakness. The Chicago purchasing manager’s index and consumer confidence both came in weaker than expected. All the negative data pushed the dollar and stock prices lower. Part of the thinking was that the Federal Reserve would be able to back off the interest rate increases, but not so!
Early in today’s session, bonds were flat, the dollar opened lower and stocks began with a modest bid. As the good news rolled in, the dollar reversed direction, bonds began to sell-off (pushing interest rates higher) and stock prices continued to march higher led by technology shares. The ISM manufacturing report was the big one traders were waiting for today. Weakness in the report would have added confirmation to yesterday’s numbers and meant the Fed could at least pause on rate increases. As it turns out, the report came in better than expected with a reading of 56.7 following 54.8 in January. Consensus expectations were looking for 55.5. As Bloomberg reports, “Businesses are rebuilding inventories, investing in new equipment and expanding production capacity to meet demand. Strength in manufacturing and accelerating consumer spending will keep the economy growing and prompt the Federal Reserve to continue raising interest rates to contain inflation, economists said.”
Well, there you have it. The consensus view says the central banks around the globe will be able to inflate their way all the way through any kind of correction we would normally be getting in overvalued paper assets. Banks continue to increase monetary aggregates (true inflation) while raising interest rates to fight inflation. I believe the real game going on behind the scenes is to play the interest rate game with the goal being relative currency valuations.
It is widely expected the European Central Bank will increase rates tomorrow and the recent weak economic data suggested the Fed might need to hold off on their next rate increase, thereby creating dollar weakness. Similarly, the economy in Japan has been improving and the Bank of Japan has been saying they will raise rates and stop the fiat money pump which keeps the yen weak relative to the dollar. The problem now is with China, because if the dollar weakens so does the pegged yuan. Japan cannot afford to allow the yen to appreciate significantly against the yuan since China is their biggest competitor for export business. The strength in the ISM report allows the Fed to continue tightening. For now, the yen carry trade is still alive and well! (Borrow yen at 1% and invest in U.S. stocks and treasuries at 4.5%. It works until the yen begins to appreciate with a sustained trend versus the dollar.) I believe the recent appreciation of the yen and rhetoric from the BOJ is the warning shot across the bow that the yen carry trade will begin to unwind in earnest sometime in the coming year. All of the powers that be want to see the unwinding of the carry trade happen in an orderly fashion without a massive rush to the exits.
Now back to the resilience of the U.S. economy, personal spending and incomes. The Commerce Department reported today that U.S. incomes rose 0.7% in January and consumer spending rose 0.9%. Yes, you guessed it; debt continues to move higher as the personal savings rate fell to negative 0.7%. Savings have been negative for eight out of the last ten months. To make matters worse, the 0.7% gain in personal incomes was largely offset by consumer inflation of 0.5% for the month of January. The Fed reports core inflation of 1.8% annualized, but the January figure translates to 6% annualized and I believe the 6% level still understates our true inflation rate.
As inflation continues to erode the purchasing power of your income, the Fed is sure to continue raising rates. As it stands, interest rate futures show traders are pricing-in a 98% chance the Fed will move to 4.75% when they meet on March 28th and roughly a 3/4 probability they will go to 5% at the meeting on May 10th. Ya gotta love that “strong dollar policy.” Continue to pump the liquidity and by the end of March stop reporting the M-3 money supply, raise interest rates to protect the dollar, understate inflation, and keep a lid on precious metals and commodity prices as best they are able. Note the recent change in the CRB index (broad measure of commodity prices) wherein they moved from “straight-line indexing” to “weighted averages of components” on a monthly basis. Some of my wording could be slightly off on the changes to the CRB, but you get the drift.
On to Construction and Housing
The Commerce Department said outlays on U.S. construction projects increased 0.2% while economists surveyed by MarketWatch were expecting outlays to increase by 1.3%. It sounds like the builders are beginning to back off as the inventory of unsold homes creeps higher. Frankly, I expect housing to continue its cooling trend, but I don’t think home prices are ready to cave-in just yet. I tend to be early on my predictions, so I’m trying to force myself to slow down. Think of the U.S. economy like trying to park an aircraft carrier at the dock. If the Captain comes into the harbor at 30 knots, he will probably be parking about a quarter-mile inland. A big ship like that needs to start slowing down while still many miles out to sea. A better clue for the big slowdown in housing will be long-term interest rates and the shape of the yield curve. The curve can remain inverted to flat for many months to come. When long rates move notably higher, home prices should flatten out and actually decline in the “hot” markets.
Today the Office of Federal Housing Enterprise Oversight said the average U.S. home increased 12.95% in 2005 and 2.9% from the third to fourth quarter. According to an article on FxStreet, “Phoenix and Arizona continued to be the metro and state with the largest price gains in the past year. The Mountain states overtook the Pacific states as the region with the largest gains, OFHEO said.”
The Mortgage Bankers Association reported its application index fell 1.2% with the purchases down 1.9% and refinancing a tick higher by 0.1%. Applications are down by 19.5% and re-fi’s are down by 31.0% from a year ago, but remember they are coming off VERY high levels. As we get closer to the end of the school year I expect the activity to increase modestly; however be sure to keep an eye on the long end of the interest rate curve. If it moves sharply higher, you need to picture the aircraft carrier throwing the propellers into full reverse. For now, the MBA reported 30-year fixed rates four basis points lower at 6.18% and the average one-year ARM four basis points higher at 5.64%.
Checking Back on the Markets
As I said earlier, the ISM manufacturing report was the big driver today as the strength indicated the Fed will continue raising interest rates to control inflation and prop-up the dollar. Bonds were fractionally lower for the session. The U.S. Dollar Index held modest gains to close 0.11% higher at 90.18 with the euro pulling back to close flat for the day at 1.1925. In light of the dollar reversal, gold and silver held up fairly well with spot silver closing flat at $9.74 and gold adding to yesterday’s gain another $1.90 higher at $563.40.
I’ve been calling for a short-term correction in the precious metals, but with the economic and geopolitical uncertainty ruling the day it’s anyone’s guess as to the short-term direction. If the Iranian oil exchange opens later this month you can expect gold to move higher in dollar terms, but probably remain flat when priced in euros. Long-term I expect gold, silver and commodities to move higher since you can’t print them up ad infinitum like you can with fiat currencies. We are in a long-term commodities bull market. There has not been enough capital invested toward infrastructure to harvest the world’s commodities, especially with the growing global demand. There has also not been enough restraint on money creation; therefore commodities still have a great deal of catching-up to do!
There was a bigger than expected build in inventory for both crude oil and unleaded gasoline today, but traders appear more concerned with the geopolitical tensions. Crude closed $0.54 higher at $61.95/barrel and unleaded gas closed three cents higher at $1.62 a gallon. Word in the energy pits said there was a possible sabotage of Chevron controlled facilities in Nigeria.
When I work to analyze the markets, I have made some errors because I rank my priorities with fundamentals first, technical analysis second, and geopolitical considerations third. The markets today are ruled by politics first, then fundamentals and technicals. A recent guest on CNBC went so far as to say “remember we are dealing with managed markets.” Everyone seems to think it’s OK for the government to “intervene” in the currency markets because, “Hey, we have to protect the dollar.” As soon as an analyst refers to “market manipulation” most of the readers just close their ears. Frankly, given the huge global imbalances we have today, I’m actually quite surprised at how good the Working Group on Financial Markets is at managing stability in the markets today. It’s amazing what they can do with unlimited capital and massive leverage in the futures markets.
This reminds me of a recent article I read on Financial Sense by Puru Saxena called, “Fuel – The Catalyst.” The beginning of the article reads:
“Under normal circumstances, I would avoid discussing politics. However, this is not a normal situation and therefore I want to highlight some key facts.”
“Whether you are aware of it or not, we are living in a highly inflationary, war cycle. The money supply is surging at an alarming rate and nations continue to out-bid each other for natural resources. In a nutshell, the mad scramble for commodities is on! Unfortunately, this dangerous fight may only get worse in the future. Glimpses of this are already unfolding with the geo-political unrest brewing in the middle-east.”
Big Picture on the Stock Market
The Dow Transportation Average has made another all-time high!! Is this a head-fake to draw-in unsuspecting investors or is this the real deal for a big, new bull market for stocks? I’m no Dow Theory expert (you need to check with Richard Russell or Tim Wood for an expert opinion). However, I do believe a bull market based on Dow Theory must have new highs confirmed in both the Industrials and the Transports. So far we have new highs in the Transports, but not in the Industrials.
We must ask ourselves if the Dow Industrials are going to break-out above 11,700 to make new highs or if the new highs in the Transports are just a blow-off. Based on what I see on the one-year daily chart of the Dow Transports, it appears more likely we will see a pullback in the Transportation Average. The rising wedge reversal pattern appears with MACD at blow-off levels and the Relative Strength Index is not confirming with new highs. Some analysts (perma-bulls on TV) believe we will see the Industrial Average break-out to new highs thereby confirming the strength in the Transports. You make the call for yourselves and your portfolios. I’m never a popular guy when I say the stock market is going to decline, but I have to call it the way I see it! Time will surely tell.
Have a Great Evening!
Mike Hartman
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