A belated good Sunday morning. Markets ended the week down, despite Friday’s rally. The one-two punch of robust global inflation and rising bond yields may have finally disabused those hoping for a rate cut for Christmas this year.
Traders seemed to suddenly ask What? Inflation?. That query led the
Dow Jones Industrial Average down 1.8% on the week. The S&P 500 dropped 1.9%,
abandoning, at least for now, its breakout over the March 2000 closing high of 1527. Whether that
turns out to be have been a bulltrap will be determined in relatively
short order. The Nasdaq held up surprisingly well, falling only 1.5%. Small caps in the Russell 2000, however, took a 2.1% hit. But the real whackage was elsewhere: Global stocks and emerging markets took a 2.4% drop, while REITs lost 3.7% and European stocks took a 3.8% drubbing. Oil fell half a percent, and Gold dropped 3.8%.
While some were quick to blame Fed Chef Ben Bernanke for the sell off, I credit selective perception. Its been readily apparent for quite some time that the slowing economy could have used a rate cut, but inflation concerns prevented the Fed from doing so. Easy Al left Helicopter Ben grounded, with the Fed painted into a corner. The sudden recognition admission of this led to the increased volatility.
A few weeks ago, Fed Fund Futures were forecasting 3 possible cuts by year’s end. Now, the odds favor at least one hike. I admit to being perplexed as to what suddenly changed the minds of so many bond investors in so short a time period. But change they did, sending the
10-year yield to a 10-month high of 5.12%.
Given the newfound inflation fears, the key economic releases to watch this week will be price related: Wednesday has both May Retail & Food Sales, as well as Import and Export Prices (Consensus = 0.3%). Thursday we get the May Producer Price Index (0.6%); Friday is the biggie: May Consumer Price Index (0.6%). I hate to even mention the core expectation, because I find discussing inflation ex-inflation so absurd, but I am apparently in the minority on this — consensus for the core is 0.2%.
Regardless, this looks to be an interesting week. We got it all covered in yer weekend linkfest:
INVESTING & TRADING
• Global Rate Forecast: Up: SUDDENLY, IT’S NOT SUCH A LOW-RATE WORLD. Four months ago, Business Week’s cover proclaimed "It’s a Low, Low, Low, Low-Rate World," and that it would stay that way. Since then, the benchmark Treasury 10-year note edged down to around 4.50% — near the low end of its trading range over the past year — in March before jumping to nearly 5.25% by Friday, which marked the high end. Moreover, almost all of that rise has come in the past month or so. (Barron’s) If no Barron’s, go here.
• Investech’s Jim Stack called the Shanghai market correction on June 1: "This is not going to end well!"
• The Wall Street Journal noted that Mortgage Jitters May Account For Bond Selloff: The 10-year Treasury had its biggest decline in two years, driving its yield to 5.1% from 4.97%. Commentators were quick to latch on to reasons for the move, such as rumors the Chinese government was selling in the morning. But the biggest factor behind the drop looks like it was mortgage investors, who had been holding out in hopes yields would go lower. (If no WSJ, What Do Mortgages Have to Do with Bond Yields?)
• That didn’t take long: Last week, we mentioned the significance of quantitative research supplanting traditional fundamental work. Well, here’s some of the fall out: Prudential shuts down stock research, trading arm: Prudential Financial Inc. said on Wednesday that it will shut down its stock research and trading business, in the insurer’s latest pullback from a rocky 26-year stay on Wall Street. The company said it is closing down Prudential Equity Group’s offices and trading operations in nine U.S. cities as well as in London, Zurich, Paris and Tokyo. Prudential dropped research coverage immediately and said 400 employees will be terminated as operations are wound down during the quarter ending June 30. (Reuters)
• Wealth Hazard: Guessing Low On Profit Growth: Investors were surprised by the strength of corporate profits in the first quarter. They’d be wise to avoid getting surprised again this quarter. By Thomson Financial’s count, per-share earnings by companies in the Standard & Poor’s 500-stock index rose 8.2% in the first quarter from a year earlier, better than the 3.2% gain analysts expected in early April. Analysts and some executives appear to have extrapolated a weak U.S. economy into weak earnings growth. They didn’t count on overseas economies thriving despite the U.S. slowdown, or the weak dollar bolstering earnings from abroad. (Wall Street Journal)
• Mark Hulbert asks: Is It Just a Strong Market, or the Bubble, Part 2? “P/E ratios based on 10-year average earnings, adjusted for inflation, make much more sense for this purpose,” he added. And though that 10-year average ratio for the S.& P. 500, now at 27.4, is lower than it was in March 2000 , when it stood at 46.1, it is still at one of its highest levels ever. Other than the years associated with the Internet bubble, in fact, there has been no period since 1929 when the 10-year average was higher. (New York Times)
• Some of my long-term macro themes — rising inflation, slowing economy, subpar job creation, and ongoing drag from the housing slowdown — have been causing some turmoil in the markets lately. Despite this — or perhaps, because of it — we’ve gotten a number of inquiries from our clients as to How to Play the Long Side SAFELY (Real Money)
• US equity returns: what to expect An interesting multi-year comparison of the price-earnings (PE) ratios of the S&P 500 Index (as a measure of stock valuations) and the forward real returns was done by Plexus Asset Management. The study covered the period from 1871 to 2006 and used the S&P 500 Composite Index (and its predecessors). In essence, a total real return index and coinciding ten-year forward real returns were calculated, and used together with PEs based on rolling ten-year earnings.
• The triumphant return of the Magazine Cover Indicator
• Is that a technical term? Long Up The Wazoo, They Are:
"We’ve already seen it happen with the hedge funds, which, if you look
at the ISI numbers, are about as long as they could get."• How Liquidity May Take Its Toll On Value of Assets World-Wide:
Economies depend on a stable monetary system to send appropriate price
signals to producers and consumers. But with the M3 measure of money
supply rising at close to 10% annually in the U.S. over the past dozen
years, and world central-bank liquidity growing by 13.8% annually, the
system is anything but stable. Normally, such excessive money creation
would have produced inflation. But this time, it coincided with a
communications revolution that lowered global production costs.
Previous revolutions of this nature, like the one brought on by
railroads, steamships and refrigeration in the 1880s, produced price
declines. This one has merely offset the inflationary pressures caused
by the increase in money supply. (free Wall Street Journal)• Wall Street’s biggest Apple bull: A Look Inside Gene Munster’s Crystal Ball (BusinessWeek)
• This is way cool: The Profit Calculator: You can’t live in New York—arguably, you can’t spend an hour in New York—and remain oblivious to the machinery of profit pumping away under every surface. This city makes money, loses money, houses money; lately, with luxe condos stacking up like casino chips along the waterfront, the city looks like money. What’s amazing, then, is how little we truly know about the inner workings of this beast we feed, and milk, daily: How does New York make its money? (New York Magazine)
• This is an instant classic: Top Sell Side Clichés
ECONOMY
The Wall of worry continues to build:
• I got your second half recovery RIGHT HERE: Duke University study finds CFO Optimism Falls; Capital Spending and Hiring to Slow See also "CEOs cautious about the economy" (Reuters)
• After 6 years of falling, US Labor Participation Rates were improving — until recently: More on NiLF & the Unemployment Rate See also Will the Real Private Nonfarm Payrolls Please Stand Up?
• Gas prices are budget busters for many:
On average, U.S. households spent 3.6% of their after-tax income on
gasoline in 2005, the period of most recent data. That trails expenses
for food, housing, health care and entertainment. But spending on
gasoline ate up more than 9% of after-tax income for households in the
lowest income bracket in 2005, according to the government. For those
people, swings in gasoline prices can have a profound impact. (USA
Today)• The Real Cost Of Offshoring U.S. data show that moving jobs overseas hasn’t hurt the economy. Here’s why those stats are wrong (BusinessWeek)
• Go figure: Indian wage spiral forces TCS to outsource in Mexico: The increasing cost of labour in India is forcing the country’s largest software services provider to hire 5,000 employees in Mexico. Tata Consultancy Services (TCS), which opened a software development centre in Guadalajara, Mexico, last week, will outsource the first 500 jobs from India in this financial year. A further 4,500 jobs will follow over the next five years. A talent supply crunch in the booming services sector in India, coupled with a sharply appreciating rupee against the dollar, is threatening to knock the country off its perch as the world’s leading outsourcing centre. (The Times)
HOUSING• The NAR Housing forecasts have been laughably wrong: NAR and Housing Forecasts
• It takes a special type of stupid to so belated recognize the impact of housing on the broader economy: Economists See Housing Slump Enduring Longer: Economists are giving up on the idea that the U.S. housing slump will be quick and relatively painless. Instead, more are concluding, the downturn that began
nearly two years ago will last at least through the end of 2007,
remaining a major drag on the U.S. economy. The culprits: a glut of
homes for sale and growing caution among lenders who now regret being
so free with their mortgages during the boom. (Wall Street Journal) Dimwits See also Shoppers for Mortgages Say ‘Ouch!’ (free Wall Street Journal)• Housing Inventory Build Worsens
• Did Greenspan Add to Subprime Woes? [Why am I not surprised?] A former colleague says Mr. Greenspan blocked a proposal to increase
scrutiny of subprime lenders under the Fed’s broad authority. That
added scrutiny might have helped curtail questionable lending practices
now blamed for soaring defaults by mostly low-income borrowers.
Democrats in Congress are now turning up the heat on regulators,
especially the Fed, for failing to do more to stamp out those
practices, and the Fed appears increasingly likely to overhaul its
approach. See also More Mortgage-Industry Firms Subpoenaed as Probe Expands (Wall Street Journal)• Get Your Red-Hot Foreclosures Here: Foreclosures have surged in Southern California in the last year, particularly in outlying areas. In seven counties, lending institutions foreclosed on 6,007 properties in the first quarter of 2007, up from 721 properties in the first quarter of 2006, according to DataQuick Information Systems, a research company based in San Diego. In Riverside and San Bernardino Counties, lenders foreclosed on 255 homes in the first quarter of 2006. That number grew to 2,369 in the first quarter of 2007, according to DataQuick. (New York Times)
WAR/MEDIA/POLITICS/ENERGY
• Hey, big spender:
China’s investments in the rest of Asia are booming. China’s outward
investment drive has become the subject of growing media and political
attention, as increasingly internationally minded Chinese companies
have begun scouring the globe for takeover targets. Yet despite the
hype, this shopping spree is not quite what it appears, being in some
ways more modest in ambition (for now, at least) than many suppose.
(Economist)• Why Iran will fight, not compromise: What can the West offer the Islamic Republic of Iran in return for giving up its nuclear ambitions and kenneling its puppies of war? The problem calls to mind the question regarding what to give a man who has everything: cancer, AIDS, Alzheimer’s, diabetes, kidney failure, and so forth. Iran’s economy is so damaged that it is impossible to tell how bad things are. Except perhaps for the oilfields of southern Iraq, and perhaps also northern Saudi Arabia, there is nothing the West can give Iran to forestall an internal breakdown. (Asia Times)
• Big Solar’s day in the sun: This is not the same old pipe dream. The economics — and the technology — of turning light into electricity have changed. Business 2.0 has the inside look at the industrial-strength power plants coming soon to a grid near you.
• Bleep Deprivation: Indecency is different from obscenity. Obscenity can be
regulated, since courts have held that it is unprotected by the First
Amendment. But the mere recitation of dirty words does not meet the
Supreme Court’s definition of obscenity, which requires not only
extremely raw depiction or description of sex acts but also a context
that "lacks serious literary, artistic, political, or scientific
value." In contrast, mere indecency is a notch less offensive than
obscenity, and it can occur in works that have unquestionable social
value. (Fortune)• Trembling Over Tainted Food? Here’s a Solution (Bloomberg)
TECHNOLOGY & SCIENCE
• When any tech toy comes out and makes my technophobe wife go Holy $#@&!, there’s something big going on. (Yes, its another Apple iPhone story)
• Rather amazing: 6 Ways to Find Cool Google Maps Street Views
• Microsoft Finds Legal Defender in Justice Dept: Nearly a decade after the government began its landmark effort to break up Microsoft, the Bush administration has sharply changed course by repeatedly defending the company both in the United States and abroad against accusations of anticompetitive conduct, including the recent rejection of a complaint by Google. (New York Times)
• Terribly amusing In Search of the Real Fake Steve Jobs
• Tivo HD drops its price in half to $400
• Keeping legit online music alive Terrestrial radio only pays royalties to composers. Performers are not compensated, because radio stations argue that drawing listeners to their music is essentially free advertising. But Internet and satellite radio broadcasters have to pay both the composers and the performers. Satellite radio does this by paying a flat fee of 7.5 percent of revenue. Until now, small Internet radio broadcasters, too, have been able to pay royalties as a percentage of revenue. (Chicago Tribune)
• Can Blogs Become a Big Source of Jobs?:
The bottom line is this: while running a Web log is a skill that more
and more employers seek in their employees, finding full-time work in
that world is still unusual. (New York Times)• Smallest galaxy hints at hidden population
MUSIC BOOKS MOVIES TV FUN!• The most influential album in rock history: It was 40 years ago today — well, last Sunday — that ‘Sgt. Pepper’ told the band to play.
• Really? This is the last epoisode of the Sopranos? I hadn’t heard. One Final Whack at That HBO Mob
• Very funny interview with the cast of Ocean’s 13
• I was surprised to learn that Bob Dylan wrote every pop hit of the past 35 years (quite amusing!)
• Fascinating photo essay: What the World Eats
Pardon our tardiness, but some editorial
issues prevented the publication of this yesterday (Congratulations to Ross Snel on the birth of his first child!)
A few weeks ago, Fed Fund Futures were forecasting 3 possible cuts by year’s end. Now, the odds favor at least one hike.
Could you elaborate on the above? Fed Funds Futures are priced based on the average level of the Fed Funds Rate for the expiration month. Options on Fed Funds Futures are necessary to derive the probability distribution of the different possible rates.
Fed Funds Futures and options were predicting a 10%-ish chance of a 25 bps cut at the August meeting on May 7th. On June 7th, there’s no longer any chance of a change at the August meeting; but the September meeting has about equal, although small, probabilities of a cut and a hike.
I have to disagree with Business Week’s assessment that offshoring is exagerating productivity – when in fact it is underestimating it and no better source explains this than Mark Twain.
When Tom Sawyer was given the task of whitewashing a fence, he offshored that task to a group that finished the job in a fraction of the time, thus dramatically increasing Sawyer’s productivity.
By this same greater fool theory, if we could find a way to offshore all U.S. tasks, our individual productivity would dramatically increase by having someone else do our jobs, which would of course result in higher pay for us for doing nothing, leaving more disposable income for consumption, which would, of course, boost GDP.
The pain in Spain is mainly housing gains. By jove, I think he’s got it.
About the shortage of skilled labor in India
The way the global economy is organized now is quite effective and efficient at finding untapped or under-priced resources – Soviet oil or Indian college graduates or somewhat literate Chinese workers leaving the countryside who need jobs – plugging them into the global system and making a fair amount of money for the resources and huge piles of money for those who make the connection (in the cases above, Russian oligarchs, Indian software companies and their global clients, and multinationals who shift production to China, respectively).
However, the long-term question is whether or not the current market economy will be able to direct the funds necessary into creating future resources, which is harder than just tapping into resources created outside the market economy. If not, we will face increasing levels of personnel shortages and unemployment at the same time.
India is falling short in this regard and there are signs of the same in the US. Tuition is so high that students need more money than federal loan programs allow and fall afoul of less regulated loan programs. A Montana newspaper reported today a shortage of psychiatrists there because the average psychiatrist leaves school with $200,000 in debt and is thus forced to go where the money is highest.
You are not alone. I have been tracking food, utility expenses, gas prices etc. and saw 17% inflation last year, and 12% this year… These are my real rates of increase for the things I pay for. Inflation has been with us a while. I guess some are just late to the party!