Weekday Commentary from Jim Puplava
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Guest Editorial 6/21 |
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Market WrapUp for the Week
Monday l Tuesday l Wednesday l Thursday l Friday
Friday's Stock Market WrapUp
Hurricane Brewing
I could begin this weekend summary like I do every other week, with topics that look more like the same. We had plenty of companies disappointing on the earnings front. There were plenty of new accounting scandals, new SEC probes, and CEO’s or CFO’s that quit or were fired from their jobs. If there was any good news, it was the FBI wasn’t making arrests of corporate executives and could now concentrate on terrorists instead of corruption. There were also the growing tensions in the Middle East, which I will have more to say about much later. If there was anything different this week over last week, it was that investor psychology was changing, and another hurricane was beginning to form in the currency markets off the shores of Latin America.
The Housing Bubble
A remarkable sea of change is taking place with individual investors. Investors aren’t responding in the usual fashion to economic numbers that on the surface appear to look good. The leading indicators rose last month. The Fed’s June Factory Index increased, yet there was no market response. It may be that it just doesn’t feel like a recovery to most people. Company profits are down and workers are still losing their jobs. If the recovery is around the corner, it doesn’t do much for the economy. Very few companies outside the home mortgage and security business are hiring new employees. With profits still heading south, companies are reluctant to spend money on capital equipment. If the economy is getting better, debt steroids are driving it. The Wells Fargo Home Equity Branch in Carlsbad, California employed 94 workers to process second mortgages and home equity loans. The company plans on adding 50 immediate positions and an additional 70 before the end of the year. With mortgage rates at near record lows, homeowners are tapping into their home equity to remodel, pay for college, take vacations or buy new furniture or new cars. It appears that one of the few sectors holding up the economy is the housing bubble, and the ability of consumers to tap into that bubble.
However, outside of the housing bubble and the growing debt levels of consumers, there aren’t any strong catalysts besides government deficit spending to hold up the economy. One reason the markets may not be responding to the economic data is growing fears that the Fed’s next move will be to raise interest rates in order to defend the dollar. Rising interest rates would put an end to the refinancing boom, which is propping up housing and consumer spending. Another suspicion the markets may now have is the economic numbers themselves. As good as the numbers sound, when they are initially reported, investors are starting to catch on to revisions. The Commerce Department reported that factory orders grew by 1.2% in April. This week those numbers were cut in half in a later revision. This occurs quite frequently. The latest economic reports paint a much stronger economy until the numbers are later revised. When that happens, the economy appears less robust. Many of the economic numbers reported simply don’t jive with one another. We have a lower unemployment rate, yet the hours worked in the economy are decreasing. Just as we need greater accountability in corporate reporting, the same can apply to the statistical wizardry of the government’s economic numbers. They can magically make productivity increase, economic growth look stronger and the employment rate much higher. The fact that the markets aren’t responding to these numbers anymore reflects a growing bear market psychology. This is an important change in trends. It appears the accounting shenanigans, the corporate scandals, and the conflicts of interest on Wall Street are starting to have their effect. Trust has been lost, or at the very least, is waning.
That is why I believe housing is doing as well as it has recently. Money is being shifted from intangible assets to tangible assets such as housing. Investors may feel much more comfortable with something they can see, unlike the stock market, which has gone down these last two and a half years; housing prices are still rising. Investors are focusing on the present and what they know, that stocks are down and housing is up.
The Currency Market
The other big story this week occurred in the currency market. One by one, Latin American currencies are starting to fall like dominoes. It began with Argentina last year when they devalued their peso and defaulted on $95 billion in debt. It is now spreading to Brazil. Brazil’s currency is down over 17% and many of the nation’s companies are facing a credit squeeze. With the currency in a freefall, and interest rates approaching 20%, many companies will not be able to roll over their debt. Brazilian companies face close to $16 billion in debt that matures this year. The government itself is running a deficit and has been forced to pay interest rates that are 13% over Treasury rates. The government is going to have to tap into a line of credit with the IMF. IMF loans come with strings attached and loan covenants that are more harmful than helpful in restoring economic growth.
In addition to Brazil, the dominoes continue to fall in Venezuela, Uruguay, and Mexico. Mexico’s Finance Minister has already hinted that the country may soon be running out of assets to sell to balance its budget. Unless Mexico cuts spending and raises taxes, according to the Finance Minister the country faces the same fate as Argentina. It is so bad in Argentina that the economy has resorted to a barter system because there is no access to cash, and what cash is available is worthless.
In Uruguay this week the Economic Minister, Alberto Bension, and the Central Bank President, Caesar Batlle, decided to let the nation’s currency, the peso, trade freely. The currency is falling like so many other Latin American currencies this year.
The freefall in currencies continues north into the U.S. where the dollar has fallen sharply this year against major currencies such as the British Pound, the Euro, and the Japanese Yen. The growing U.S. trade deficit combined with deteriorating financial markets in the U.S. is causing international money flows to come to almost a halt. In many cases foreign investors are pulling assets out of the U.S. and seeking a safer haven elsewhere. It is one reason a few economists are starting to predict the Fed will be forced to raise interest rates later on this year in an effort to defend the dollar. For trade deficits, it looks like there will be no short-term relief. Part of the trade deficit is structural. America must import 60% of its energy needs. Crude oil for July delivery is rising as high as $29.36 a barrel. With declining oil reserves and no energy plan to replace them, the country has become totally dependent on foreign sources of oil to supply most of the country’s energy needs.
This is why many feel the Fed has cooked its own goose. If the economy falters in the second half of the year, the Fed may not be free to lower interest rates to combat a recession. Raising rates or lowering them causes damage in either direction. If rates are raised they may help the dollar but harm the economy. If rates are lowered they may help the economy but damage the dollar. In essence, the Fed has its hands tied. The fate of the dollar and the American economy is now in the hands of foreigners. They won much of our debt, both government and corporate, and hold a sizable amount of our stock market. The Fed is in a catch 22 situation. Many believe with very little room to maneuver the Fed will opt to do nothing other than keep the money supply growing in order to feed the credit bubble that is still inflating.
It is not a good position to be in, and is one reason why I feel Wall Street’s second half economic recovery isn’t realistic. In fact, the 30% earnings projections for the third quarter, and the 40% gains for the fourth quarter are looking more like fantasies. Most of the companies reporting this quarter see no recovery in the months ahead.
Middle East Violence
Another story having an impact on the markets this week is the growing violence in the Middle East. Palestinian terrorists have been on a rampage this week killing innocent women and children. One only wonders why the Israelis have not struck back much harder this week. It reminds me of a similar situation before the Gulf War. The U.S. restrained the Israeli’s from responding to Saddam’s missile attacks while a major military campaign was being planned. It may be what is now holding back Israel. What is known at the moment is that a major U.S. military buildup is occurring in the region. Troop strength has been brought up to 100,000 and still growing. The production of smart bombs at Boeing has tripled since the beginning of the year. Fighter planes and bombers are also being flown in. The growing military buildup goes beyond what would be necessary to mop up Afghanistan. Something bigger is being planned, either as soon as this fall, or next year.
The Financial Markets
It was another ugly week for the financial markets with the S&P 500 Index falling below 1,000 for the first time since the aftermath of the September 11th terrorist attacks. For the week the S&P 500 lost 1.8%, bringing its YTD losses to 13.84%. The Dow lost 2.3% with losses of 7.66% for the year. The Nasdaq is getting hammered each week, with another loss this week of 4.2%. The index has been hemorrhaging since 2000. This year it is down by double digits again with YTD losses of 26.12%. Part of this week’s decline can be attributed to quarterly "triple witching," which is the expiration of stock-index futures, index options and options on stocks.
The money flowing out of the market slowed down this week with only $300 million moving out of stock mutual funds. This compares favorably to the outflow of $5.2 billion the previous week. The heavy volume on Thursday and Friday shows that we may be close to reaching a short-term selling climax. Heavy volume on down days and rising volatility levels show we are close to reaching a short-term market bottom. That could come as soon as next week. The only real winners this week were in oil, natural gas, and of course, the precious metals.
Overseas Markets
European stocks fell as reports showed French consumer spending slowed and Italian business confidence dropped, damping confidence about the strength of a recovery. The Stoxx 50 fell 11.28 points, or 0.7% to 2972.55, bringing this week's drop to 1.3%. Six of the eight major European markets were down during today’s trading.
Japan's Nikkei 225 stock average fell, poised for its worst week in more than 15 months, led by exporters such as Sony Corp. after the yen rallied to a three-week high against the dollar. The Nikkei 225 dropped 2.6% to 10,338.04, rounding off a 5.3% slide so far this week.
Bonds Today
Treasury bonds headed sharply higher after a sour start, recovering a portion of Thursday's heavy losses. The 10-year Treasury note added 6/32 to yield 4.765% while the 30-year government bond gained 12/32 to yield 5.40%.
Next week's calendar is jam-packed with June consumer confidence, May durable goods orders, May new home sales and personal income and spending numbers.
© Copyright Jim Puplava, June 21, 2002