25 July 2008 by Richard Haskell.

The 2^nd Quarter 2008 economic and corporate earnings reports have begun to trickle in and present a mixed, though better than anticipated, picture.  As a byproduct, the DOW is up nearly 500 points and the S&P 500 is up over 50 points from their mid-July lows, the price of a barrel of oil is down nearly 16%, unemployment has remained constant at 5.5% (below the 6% post-war average), the value of gold has reversed its recent climb to nearly $990 an ounce and is now trading at just over $926 – a movement of over 6%, and the value of the US dollar has strengthened.  Corporate earnings have been mixed with some surprises coming from across the spectrum - some companies reporting higher than expected earnings and making positive adjustments to their annual guidance figures, with others reporting lower than expected results.

With all of this, the media continues its ‘gloom and doom’ portrayal of the economy, and the consumer is becoming more confused, perhaps even more concerned, than at any time in the last 10 years.  In truth, the consumer, and the economy in general, have more to applaud from the second quarter than to bemoan.  Second quarter Gross Domestic Product (GDP), the indicator of economic expansion or contraction, is now estimated between 2.5% and 3% - far beyond expectations, and obviously undermining recessionary concerns.  Real interest rates have begun to rise slightly with the 10-year Treasury Note yield rising to 4.1% from its recent low of 3.8%; enough of an increase to stem general inflationary pressures, but not enough to make substantive changes in the cost of borrowing.  While existing home sales fell by 2.6%, new housing starts increased by 9.1% and durable goods orders offered a surprising increase of another .8%. 

Earlier this year, Goldman Sachs and Morgan Stanley both offered early summer price targets for oil at $150 per barrel.  Though the oil markets came close to the $150 mark, they missed by almost $3, and it was an important miss.  Now, Lehman Brothers, a venerable Wall Street firm of considerable influence, has announced a $90 per barrel target by January 2009.  Such a decline would have tremendous impact in the stock markets, would reflect the US’s decreasing oil demand, and would likely signal a meaningful increase in the US dollar against the Euro and other foreign currencies.

It’s too early to celebrate, of course.  The US economy has a long way to go before we can use words like ‘robust’ or ‘exciting’, but indications are that the worst is behind us.  One of the sure signs that the markets have reached (or are near) relative lows, comes back to the consumer and the media.  Consistently, when the news is dire and the talk around the water cooler is bleak, it has been a sign that the markets and economy have bottomed out.  Serious investors start buying and sometimes fortunes are made.  The inverse is just as true and often as obvious.  When everyone is excited about the markets and people are doing whatever they can to buy, that’s when the professionals are starting to sell – it’s a sure sign that the markets have topped out.

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18 July 2008 by Richard Haskell.

Second quarter figures are in on the housing market and suggest that we may well have seen the bottom of the market.  At the very least, we’re enjoying a welcome break in the seemingly endless bad news cycle the housing and credit markets have seen for the better part of the last two years.

June housing starts were up 6.1%, pending home sales remained constant for the 6^th straight month, the Case-Schiller index showed an April decrease of just 1.4%, and the median price of an existing home rose by almost $7,000 over that of April 2008.  Those are important steps in what will certainly be a long road to recovery for the housing market.  Though there is still significant excess inventory to be absorbed (approximated at 14 months) and the barriers to credit have yet to ease, it does appear that the worst of the housing crisis may be behind us, and we may well see increases in property values within the next 12 months.  What is unclear is what affect the outcome the presidential election will have on these sensitive markets.  If the incoming administration is too quick to raise taxes, or puts too much pressure on the Federal Reserve to raise rates in an effort to curb inflationary pressures, it could forestall the housing recovery for many months. 

Those buyers that are fueling the early demand increases are looking for a different type of home purchase than buyers just two years ago.  There are still bargains hunters looking for severely distressed sellers and scouring the foreclosure markets, but in contrast to the market those buyers met with 6 and 8 months ago, today their target properties are receiving multiple offers and driving the prices up above what may have been expected.  Newer buyers in the market are looking for smaller, better quality, more energy efficient homes and are more inclined to be looking for a neighborhood than the isolation offered by the McMansion’s sought by many homebuyers as market values skyrocketed.  While this may not yet be the case in all markets, it is clearly the case in some of those that had been hardest hit and may represent a prudent response to the wake-up call offered as the housing bubble burst at the same time that the cost of energy began its worrisome increase. 

This ‘early demand’ signal is an important indicator of a market bottom.  Those markets that avoided the declines seen in many parts of country may also see a lag in a potential recovery, but should benefit from a market bottom none-the-less.  In the mean time, buyers have migrated to areas where housing remained ‘affordable’, perhaps relocating to other cities and towns, still close enough to commute to work, or simply accepting less expensive neighborhoods than they may have considered before.  This has helped keep those areas or market segments from experiencing meaningful declines and has distributed higher income families to areas more traditionally populated by those with lower or fixed incomes.  The result may well be a gentrification of some of these areas or at the very least providing for greater diversity among homeowners in those areas.  Some areas that had become popular for home rentals have seen families move in, purchase lower priced homes, and begin the process of improving the home and thereby the neighborhood.

It’s hard to foresee the benefits of a market in decline until afterwards.  Just as a dying tree may provide an excellent environment in which seedlings will grow, so can a difficult market offer the opportunity for renewal and recovery.

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15 July 2008 by Richard Haskell.

WHEN THE FDIC STEPS IN AND WHEN THE NATION STEPS UP - JULY 14, 2008

Last Friday’s announcement that the FDIC was stepping in and taking over IndyMac, a major mortgage lender and consumer bank headquartered in Southern California, came as no great surprise to the financial markets.  IndyMac is a major maker of ‘exotic’ mortgage financing, heavily used in the run-up of the housing market, the same type of financing that is responsible for the majority of home foreclosures nationwide.  Its stock value had suffered terribly since the beginning of the housing and credit market turmoil as the value of the real estate used as collateral for its loan portfolio had tumbled and as its expenses in servicing so many struggling loans had skyrocketed.  But IndyMac was the architect of its own demise as it aggressively marketed questionable mortgage products and highly compensated mortgage brokers to bring any and all borrowers to its table.  As the housing market heated up, IndyMac and its surrogates reaped meaningful rewards.  But in the end, some borrowers and all current shareholders are the ones who have suffered.  Depositors who have kept their accounts at or under FDIC’s coverage levels and borrowers who prudently managed their mortgage borrowing have either won out or have survived unscathed, being rewarded with higher than usual interest rates on deposits and/or low interest rates on loans.

The failure of IndyMac has been heralded as one of the largest bank failure in history, though when adjusted for inflation the failure of certain banks and savings and loans in the early 1980’s or earlier dwarf that of IndyMac’s today.  Along with concerns over the solvency of Fannie Mae and Freddie Mac, it has increased the pressure on the share value of banks, including consumer, commercial and investment banks throughout the country. 

The US Treasury and Federal Reserve have announced plans to shore up those institutions (like Fannie and Freddie) deemed to be critical to the nation’s economy, and the FDIC is closely following the capitalization and liquidity of over 200 banks nationwide, prepared to step-in where needed.

Fannie Mae (formerly known as the Federal National Mortgage Association) and Freddie Mac (the Federal Home Loan Mortgage Association) serve a critical purpose in mortgage lending. Fannie Mae considers itself ‘a shareholder owned company with a public purpose.’  Though they are publically held corporations, the stock of which can be found in untold number of stock portfolios, mutual funds, and retirement and pension accounts, they are also Government Sponsored Enterprises (GSE’s) and enjoy a relatively unique public/private status.  While they are technically able to fail, they are functionally incapable of doing so - so long as the US Government stands.  They live and breathe as chartered by the US Government and need only appeal to the House and Senate for relief.  No wonder then that the Fed and Treasury acted so quickly to restore confidence.

When the news in any industry segment is as difficult as it is for the banking industry, most investors choose to flee, leaving their stock positions with little of what they may have brought to the table.  But it begs the question, ‘who are the buyers for those battered shares?’  The most often answer is ‘the professional investor looking for bargains they expect to turn into substantial long-term gains.’  They are acting out the stock market idiom of ’buy low, sell high,’ and they have the courage and temperament to wait for their gains.  The Warren Buffet’s and Kirk Kerkorian’s of the world have made their fortunes with such strategies, while the average investor settles for significantly lower returns.  As the markets get tough and share values seem depressed, when we are besieged daily with the purported woes of the economy, and the talk-around-the-water-cooler is replete with concerns over the future, that’s the time to pay attention and look to reposition your portfolio to take advantage of the opportunities such seemingly dismal times afford.

Former Senator Phil Gramm, a top policy adviser of Sen. John McCain’s, recently said the nation is in a “mental recession,” not an actual one, and suggested the United States has “become a nation of whiners.”  This comment was certainly great fodder for the media, perhaps bad form for one acting as a surrogate for a presidential candidate, and obviously not what any populist- minded politician wants repeated countless times on the Sunday morning political programs, but maybe not as far off as some would suggest.  For those having a tough time paying for food and fuel or those whose families are directly effected by home foreclosures or unemployment, it likely seems like a recession, and in their homes it certainly is one.  But is the nation in a recession?  Or was Gramm correct?  What does it mean to be in a recession, and can the economic slow down of our domestic and global economy qualify?

The textbook answer is that a recession occurs when the economy has decreased in overall size (as measured by GDP) for two consecutive calendar quarters.  So here’s the rub, our economy has yet to evidence that we’re in a recession.  An economic slow down?  Certainly.  A period of time when it’s difficult to see economic progress?  Of course.  But just because we can’t easily see the progress doesn’t mean it isn’t there.  Manufacturing orders are up, unemployment is holding at a relatively low 5.5% (low compared to historic recessionary levels), corporate profits are amazingly consistent and robust in the face of extraordinarily high energy prices and unusually tough credit standards.   Housing, banking, and transportation companies have taken the brunt of the slow down, but other segments are performing well or in some cases exceeding expectations. 

So maybe there’s credence to Gramm’s assertion that we’re in a ‘mental recession’, but what about the cut suggesting that ‘we’re a nation of whiners’?  If you judge us by our emotional reactions and fears alone, then Gramm was right.  But that’s too narrow a judgment and too broad a condemnation.  If Gramm had said that for a nation of remarkably resilient people, of committed and hard working individuals and families, of self-sacrificing and good hearted contributors, we seem to whine a little too loudly when pinched, then his comments may have struck a completely different chord.  I’d like to think that someone of Gramm’s stature, representing either of our presidential candidates, would have enough faith in us as Americans to simply have meant that sometimes we should remember how great our lives are before we whine about how bad things seem at any particular time.  After all, we live in the greatest country on earth and have and will continue to enjoy the benefits of the largest, most resourceful and most resilient economy ever witnessed.

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14 July 2008 by Richard Haskell.

The role of speculators in the oil markets has been much maligned of late, perhaps for good reason.  Traditionally, speculation and speculators provide for a much needed source of liquidity; as in the case of the farmer whose bean crop is still in the field, but needs the cash to pay for the seed or taxes, etc.  A speculator steps in, offers so much per bushel today and then bears the risk that bean prices will still be at that level or higher once the crop comes to market.  The farmer gets his money and avoids ongoing risk, the speculator hopes to get his money back and make a profit.  Both sides are happy.  But sometimes the farmer can’t get as much as he needs because so many farmers planted beans that year, or the speculator finds that climate conditions made for a bumper crop for beans and there are so many beans available that they’re worth less when brought to market than he thought they might be.  Other times just the opposite is true and the speculator can make extraordinary profits.  Speculation and speculators aren’t bad, but rampant speculation can bring extraordinary consequences well outside of the intended liquidity benefit for which speculation has been allowed in our economy and markets.

Commodities traders (speculators) have taken the speculation concept nearly as far as the free market system we enjoy will tolerate, perhaps further.  The executive and legislative branches of government are looking at regulating the role of speculators and tightening the system used for trading and re-trading commodities contracts.   While I would normally eschew such consideration, this may the time and oil may represent the case for it.  It is estimated that some $30 - $40 per barrel of the price of oil comes from the effect of commodities traders in the oil markets.  I’m a staunch believer in The Kudlow Creed offered by Lawrence Kudlow (Chief Economist, Prudential Annuities and CNBC/Wall Street Journal contributor) which states, ‘free market capitalism is the best path to prosperity’, but in this case we may have gone beyond the good sense employed in a free market system and extended the effect of speculation to a more detrimental end.

At a time when our economic has slowed, the value of the US dollar has weakened, and global demand for oil has begun a long anticipated climb, this level of speculative activity may be unbearable.

Jeff Thredgold, of Thredgold Economic Advisors, estimates that today’s oil pricing breaks down as follows:  of $140 per barrel some $70 represents the fundamental price based on basic supply and demand models, political an military concerns in the middle east represent another $15 in excess cost, a weaker US dollar represents another $15 and the effect of speculation represents the remaining $40.  Such a premium is crippling for many American families, certainly has an adverse effect on business, and has placed an enormous burden on the US military’s transportation budget – all at a time when the economy needs stimulation rather than the added weight of the proverbial mill stone around its neck.

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7 July 2008 by Richard Haskell.

Ben Bernanke of the Federal Reserve has suggested that the US and other international markets may not have as much impact on each other as some might have thought – a phenomenon now titled ‘de-coupling’.  This appears to have been part of the Fed’s rationale for not supporting the US dollar while decreasing domestic interest rates over the last year.  Clearly it’s time for the Bernanke to think again.  Larry Kudlow (CNBC, Prudential) has been looking for Bernanke’s ‘inner Volker’, a nod to Paul Volker (former Fed Chairman under Clinton) successfully battling inflation while strengthening the US dollar.  While the Fed most easily supports the dollar with interest rate increases, there are other means at their disposal.

US Treasury Secretary, Hank Paulson, addressed members of the United Kingdom, European Union and the international financial press yesterday from Chatham House in London and did everything he could to say as little as possible, with as many words as possible, but still evidence the US’s commitment to a strengthened dollar.  This was orchestrated to come one day in advance of the European Central Bank’s President Jean-Claude Trichet – our version of Ben Bernanke at the Federal Reserve – announcing a widely anticipated increase in the ECB’s key lending rate of .25%.  The US markets experienced a broad sell off, oil climbed to record territory, gold regained some of its recently lost value and the US dollar took a beating after Paulson’s comments, but did so on extremely light volume – that’s the good news. 

The concern is that if the ECB begins a series of rate hikes to thwart inflation in the EU, it will further undermine the strength of the dollar.  Especially in light of the fact that the Federal Reserve isn’t likely to raise US interest rates until after the presidential election, even though some modest rate tightening would go a long way to support the Federal Reserve and Treasury’s efforts to strengthen the dollar.  Fortunately, further tightening by the ECB now appears unlikely, and the Federal Reserve can rest more easily knowing that there is less pressure to tighten US rates and risk the possibility of affecting the outcome of the US presidential election.  Today the US markets are responding positively to Trichet’s follow-up comments. “Starting from here, I have no bias [on interest rates]”, Trichet told reporters at his monthly news conference, suggesting that the ECB’s rate increase is not the start of a series of increases that would further weaken the dollar.

JOBLESS CLAIMS REMAIN STEADY AT 5.5%

Last Friday the markets responded very poorly to ADP’s jobs estimates of a reduction of some 80,000 US jobs for June.  ADP, the nation’s largest payroll processing firm, is usually represents an accurate forecasting mechanism; this time they got it wrong by over 30%.  The actual jobs number is now available and reports a loss of 62,000 jobs; the unemployment rate is holding steady at 5.5%.  While this is terrible news for those looking for work and it accurately reflects an economic slow down, it’s actually better news that it sounds.  We have lost some 500,000 jobs in our economy in the last 6 months (an annual rate of 1,000,000 jobs) while the last several US recessions have been met with jobs losses at an annual rate of over 2,000,000 jobs.  Additionally, inflation is one of our greater long-term concerns and meaningful inflation can’t exist without substantial increases in personal incomes and those increases aren’t likely with unemployment hovering above 5%.

A CASE FOR THE NEXT REBOUND

Our economy consistently shows that there is more than enough capital available for aggressive investment and that money moves from sector to sector looking for values.  Unfortunately, that often manifests itself in boom and bust cycles.  This can easily be seen in the flow of funds into technology stocks that fueled the dot com bubble of the late 90’s.  As money flowed out of that sector, it rested in the real estate markets and the venerable Alan Greenspan declared that there appeared to be ‘froth’ forming in that market.  Froth, of course, is thousands of tiny bubbles – he was right.  Money then flowed from real estate into oil, gold, and other commodities and that market is now showing signs of being played out, or surely will in the near future.  Where will these aggressive investment dollars go next?  Many think that the US stock market will be the recipient.  The average P/E ratio of the stocks that make up the S&P 500 currently sits at less than 14 whereas the average P/E for those stocks usually runs in excess of 19.  Valuations are now down in excess of 20%, and the market is evidencing that it is clearly oversold.  Will a US stock market rebound come in advance of the presidential election?  Possibly so; not very likely; but that it will come is inevitable.

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