Monday, April 30, 2007

Michigan sentiment tops expectations but continues trend lower.<

- GDP a downer but market hangs onto gains to close an important week.
- 2007 output starts softer as housing, trade deficit shave growth rate, offsetting solid consumer & business spending.
- Michigan sentiment tops expectations but continues trend lower.
- Earnings trend is solidly higher through the busiest week.

Fireworks mostly over by Friday as market coasts into the weekend.

Once more there was some adversity, some intrigue to try and upset the market. MSFT beat on earnings and was up, but there were a number of other techs (mainly chips) that missed, acting as a counterbalance. As for the economic side of the coin, GDP was rather crappy at 1.3%, the lowest growth rate since Q1 2003. After four years of solid growth the economy is taking a breather, thanks in part to the Fed, thanks in part to its own success.

After the solid surge midweek that continued the nice April advance this kind of news was enough to put most investors on the sidelines. It simply was not the kind of news to get investors running after stocks with their checkbooks out again. Quite frankly it would have been hard to top the excitement from earnings. Perhaps if the inflation component was weaker instead of stronger . . . but that is a moot point as inflation continued to skulk around in the shadows.

With that backdrop stocks still managed to open positive, and added some gain on the stronger than expected Michigan sentiment report (though still steadily lower the past several months). Once more, however, the midmorning dips hit, and the indices were negative by as the first hour ended. Once more, stocks bottomed and started a steady, albeit somewhat shakier, recovery well in to the afternoon. A last hour round of selling pushed the indices negative, and a late bounce could only turn NASDAQ and DJ30 modestly positive.

For the week, however, the action was solid once more. A Wednesday burst pushed NASDAQ to a new post-2002 high and back into its prior uptrend channel. DJ30 and SP500 moved back home as well, and in truth, they were the drivers of the week as the 'old economy' stocks of the 1990's are the new economy stocks for the rest of the world as noted Thursday. We heard more than one floor trader humming 'Back in the Saddle Again' to end the week.

Technically, it was just an 'end of the week after a gain' day: mushy. For the week it was excellent action: new all-time highs for the NYSE indices, new post-2002 high for NASDAQ, breaking back into the channels. The market continued to overcome potentially distressing news in favor of better than expected earnings. There was solid price/volume action as the indices broke sharply higher. There was big leadership from those 'old economy' stocks. There are more stocks setting up to move higher as the money moves through the market in waves.

There are still issues to confront the market though ignoring them has been in vogue this month as investors throw money at stocks. That is that 'head down' rallying we refer to when it doesn't seem to matter what the news is and stocks just continue higher. Oil is surging (closed at 66.46, +1.40 Friday with gasoline leading the push into our wallets). The dollar is falling hard (hit a new all-time low versus the euro Friday). No poor dumb government ever won prosperity by devaluating for its country. It won it by making some other poor dumb government's currency seem less valuable through policies that strengthen the economy and make the country a more desirable place to invest. Devaluating only fuels inflation. Any wonder inflation is not giving in? Aside from a weaker dollar, economic data continues to come in softer overall. Earnings are indeed much better than expected, but in the bigger picture they are still decelerating. Sure they are much stronger than thought this quarter, but that doesn't mean they will surprise again, particularly with the economy still slowing some. Indeed, a lot of the strength shown in Q1 results was found in the multinationals where currency played a role to the tune of 25% of the earnings.

Plenty of issues for sure, but the market is either rallying in anticipation of something better 9 or so months down the road, or it is just flat out overrun by world liquidity. Which is it? Yes. The market looks down the road to better times and the best long leading indicators such as ECRI still show a return to better growth later in the year. As for the liquidity, that is true as well. There is so much money running through the world's financial markets it only let the US stock market take a 4 week breather. The market always overshoots in the short term so there will be some deeper test ahead after this binge higher, but it can overshoot for quite some time before that happens.


First run at 2007 GDP is basically par for the course.

Of course the expected par was 1.8% not the 1.3% that showed up Friday. 1.8% was almost in spitting distance of Q4's 2.5%; 1.3% is not even worth puckering up to give it a try. Prices were outlandish, up 4.0% on food and energy (core was up 2.2%).

To look for the drags on the number, just round up the usual suspects: housing (-17%) and the trade deficit as exports fell. Housing carved 1% off GDP and the trade imbalance skimmed another 0.5%, right off the top. Add it back in and you have a 2.8% reading. Hey, break out the bubbly; after a few glasses we can add everything back in and have a 4% growth rate.

On the positive side business investment rose 2%, nice to see a gain after the declines. Equipment and software rose 1.9% after a pitiful 4.8% Q4 decline. The consumer was great as well with a 3.8% gain on top of Q4's 4.2% rise. Gasoline is high, but wage growth and jobs are offsetting that for now. It will be interesting to see how $4/gallon gasoline impacts that this summer. Recall how post-storm 2005 prices hit over $3 and stalled demand for gasoline and curtailed some travel. It happened briefly in 2006 as well. That will make things very interesting in the Chinese curse way.

Michigan sentiment higher than expected but still lower than before.

In January the Michigan poll takers braved the cold to take the pulse of the US consumer. They found enough positive attitudes to push the results to a 2 year high. Gasoline had been on a decline since August 2006 and when gas is cheaper after a spike, consumers feel great. As gasoline jumps back up since January, sentiment has flagged. When petrol approaches $3 consumers get edgy. They don't clam up, they just get edgy.

Thus the April read was 87.1, down from 88.4, 91.3, 96.9 and 91.7. Steady trend lower, indeed a 7 month low, but expectations are up 12% from the August low, and given the rise in gasoline prices that is somewhat impressive.

Despite the trend lower, levels are still well within the range that shows continued consumer spending. The trend can always continue lower and take us into jeopardy (in the low 60's to the 50's), but there still is an awful lot of good news on the horizon to offset the economic worries of the past couple of months spurred by the sub-prime woes.

ECRI looks down the road, and as with the stock market, sees things it likes.

So much air time is spent on the economic future. The bears smell blood with the housing issues and with the Fed still in the game (at least with respect to its public image). Thrice weekly they are on the financial stations predicting a major meltdown. It just has to be. The consumer is tapped out after a buying binge. The decline in housing only exacerbates feelings of wallet impotency or purse envy. Gasoline prices will drive more nails into consumers' coffins. Earnings are declining. The dollar will implode. Inflation will spike. Foreigners will stop funding the US trade gap. The Bible talks of pestilence overtaking the world in the latter days, of seven signs of the end of the world. There are seven there that the bears cite with the regularity of someone on a high fiber diet.

The problem with those prognostications? There are at least hundreds of variables dealing with the above mentioned issues, and you can name as many countervailing issues that undermine those. These fellows cherry pick the ones that make their point and they repeat them as often as possible. Problem is, when you cherry pick with a foregone conclusion you are doing nothing more than relying on supposition based on incomplete data similar to Al Gore concluding we are the cause of the earth warming. Don't bring the sun into it; it is only the source of the heat and changes in its energy output directly impact our temperatures. Heaven forbid you include those changes in your calculations, especially when temperatures have dropped 0.04 degrees since 1978, after rising only 0.5 degrees in the past 50 years versus the 1 degree in the 100 years before that. Thus the world's temperature is not rising at a faster pace, but no one seems to be paying much attention to that fact.

The point: look at what works; look at what accurately tells the truth. ECRI has the best track record for predicting economic cycles. What does ECRI say right now on the week that pitiful Q1 GDP report was issued? The weekly gauge of activity popped to 141.6 from 140.4. The annualized growth rate rose to 4% from 3.6%. None of the ECRI data suggest the economy is going off the edge. Indeed, it still indicates, as it did early in the year, that there is growth out in the late summer and early fall after this mid-cycle slowdown. Could it possibly be this is what the market is building in? Well, yes.

By: Jon Johnson, Editor

Jon Johnson is the Editor of The Daily at

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Sunday, April 08, 2007

Bonds continue to do the Fed's work for it as they price in some inflation worries.

- Stocks rise early, rise late, close higher yet again.
- Bonds continue to do the Fed's work for it as they price in some inflation worries.
- Jobs report and revisions shows continued growth.
- Riding the low volume ripple up toward the February highs and earnings.

Sellers nowhere to be found as market melts higher, caps upside week.

For a schedule light of economic data, there certainly was a plethora of information to wade through in the pre-market. Jobless claims rose to 321K, almost smack on target (320K) and though up, at a level indicating a sustainable jobs market. Indeed, the jobs report jumped to a record level. The Bank of England left interest rates steady. China raised bank reserve requirements (for the sixth time since June 2006). Norfolk Southern railroads announced rail rates were lower and carload volumes were lower as well. Talk about a mixed bag. How would the market sort it out?

From the look of it, it ignored it all. They sized up the news and opened flat to lower. Once again, however, they started a slow, steady rise. Indeed, the price action resembled that seen in a strong bullish run higher: steady moves up, tests back to the 15 minute moving average, then another steady move higher. We anticipated some selling attempts to stall the move out heading into the long weekend and ahead of the Friday jobs report, but sellers didn't want any of that. Sure there were a couple of tries to take it lower, one right before lunch and then again in the last hour, but the market shook it off.

Ever since the two sharper down sessions two weeks back the sellers have left the building. Upside volume has not really surged (though it was fairly solid on NASDAQ Tuesday), but with the sellers AWOL, stocks could drift higher toward the prior highs. Enough so that NASDAQ and DJ30 put together a string of 6 straight upside sessions.

Technically the action showed decent price gains once more with leadership from technology (mainly large cap), some energy, metals, chemicals - - much of the same crowd crowding the leader board of late. Tuesday renewed the follow through and breakout off the early March double bottom, and Thursday and Friday kept the move alive. There was no volume as expected, and breadth remained modest. No surprises there. It was the lack of interested sellers versus a run of new buyers that is keeping this slow rise toward the February highs on track.

Some volume would be nice after the holiday to take on the prior high. If it does not get it, the ability to take out that high and continue on is low, likely leading to a test of the prior low, and that means another decline. For now we ride the move higher for what it will give us, then size up the next move when the indices start approaching those highs and exhibit signs of balking such as slowing moves and narrowing ranges, stocks leading higher starting to distribute, sharp intraday reversals. Those are classic signs when an old high is approached and a stock or index is preparing to give back some of the run.


Bond yields rising again, helping the Fed in a tough spot.

We have written about the lingering inflation that is dogging the economy thanks to interest rates held too low for too long and an initial stimulus package that only fanned demand during the economic slowdown when demand had held up quite well. Of course, the levels of inflation as measured by the Fed and its PCE and CPI are debatable; is 2% the limit the economy can withstand? Highly doubtful. It is a level the Fed has chosen, however, so that the Fed can foist upon us the policies and thus the control as it is directed by the powers that be such as administrations and the ultra rich.

That heightened inflation reading, however, is something we have to deal with because the Fed is using it as its monetary policy guide. Thus the rate hikes started by Greenspan and continued for a time by Bernanke. An interesting thing happened along the way to fixing inflation, however. The bond yield curve inverted during Greenspan's tenure. A flat curve (short term bond yields roughly equal to long term) historically suggests slowing to flat economic growth. An inverted curve (short term yields above long term yields) historically suggests recession.

There was a twist, however, due to an unquantifiable bid in US treasuries due to the 'recycling' of US dollars back to the US as part of our large trade imbalance. One of the chief sources of dollars for treasuries is OPEC as those 'petro-dollars' are turned back to the US in exchange for US treasuries which are, basically, IOU's to pay at some point. This large amount of dollars due to the price hike in oil buy treasuries, and as bonds are purchased and 'rally,' bond rates are pushed lower. The rub as Shakespeare put it, is no one, not even Greenspan, knows how much of an impact there is on treasuries.

What is more interesting is how the yield curve has responded to the Fed's actions as the economic expansion aged. As the Fed remained hell bent on stamping out inflation and talked tough about doing so, the yield curve inverted and remained inverted. As Bernanke took over and talked to Congress early on in his tenure, he got a bit too lax with respect to inflation, indicating it was possible the Fed could up and pause. The curve flattened and even reverted for a brief point; then the Fed came out with fire and brimstone, basically saying Bernanke spoke too loosely and was not being literal. The curve inverted again. Then when the Fed paused the curve reverted again. Once more, tough talk ensued and the inversion returned. After that first rebound following the 'pause' comment we opined that the market was telling us that if the Fed would lay off the curve would revert. That suggested that the market viewed the Fed's action as overreaching, i.e. likely to lead to a recession in the future.

Now with the last statement where the Fed dropped the 'further tightening' language the curve has reverted and is holding it (4.62% versus 4.68% Thursday). That suggests that despite the inflation, the market views the Fed backing off as helping preserve the expansion. Rates rise when there is economic expansion. The Thursday close put the 10 year back at the February highs. Thus the yield curve has reverted and higher rates show demand for money down the road. Higher rates are also doing the Fed's job for it if you view monetary policy only through the prism of rate hikes. Bernanke has shown us it is much more what with his rather sage management of money supply that Greenspan kept at a high growth rate thus fueling the inflation he was hiking rates to combat. Nonetheless, if it is rates you are worried about with respect to the Fed, the 'natural' rise in rates of late means the Fed is very much out of the rate hike game for now.

Jobs rebound, unemployment fades to cycle low, wages continue modest rise.

Jobs blew past expectations, coming in at 180K versus 135K expected. January and February were revised 16K higher each, bringing the 3-month average up to 152K. The unemployment rate, the so-called household survey, fell to 4.4%, matching the cycle low hit in October. Wages rose 0.3%, in line with expectations and roughly matching the range shown the past quarter. Wages grew at a 4.0% rate year/year. At this stage of the cycle they are showing the gains typically associated with an expansion. In other words, despite what many like to say, wage growth is following the typical path: it lags the overall economic recovery, gaining strength well after the recovery is underway and employment heads toward capacity.

That brings up two important points regarding the employment data. First, it is lagging. As noted, wages start to log their best gains well after the expansion is underway. Thus while it is nice to see strong employment, it does not answer the question of where the economy stands with respect to the future. It is similar to beating a weak team at the first of the season; it is nice, it is expected, but it does not tell you much about the strength of your team. Thus the economy could be slowing even as the jobs report strengthens. Indeed that is what we are seeing, but as we have said many times, this is not a serious economic slowdown, just a mid-cycle economic slowing.

Second, the payroll numbers are not as accurate as the household survey depending upon what type of recession and recovery you have. We all remember Greenspan opining to Congress that the payroll report was the most accurate, and thus the moniker 'jobless recovery' attached to this expansion. As history has shown, Greenspan was wrong on many occasions, and this is just another one in the list. The household survey or unemployment reading, however, showed consistently strong jobs growth. When people were asked if they had a job, more and more were saying 'yes,' much more so than the payroll figures reflected.

What happened was big business stopped investing and spent three years cutting its workforce sharply. With no jobs coming from the 'traditional' means, those ex-employees had to find means to make money. Thus the explosion in Subchapter S and limited liability corporations as thousands and thousands of new businesses were born. The government data did not reflect this because it was looking in the wrong places. Not until two years after the surge was this known by the government because it takes that long for the feds to acquire and analyze the data from tax returns and other filings.

Thus this recovery was much stronger than first thought. In addition, the wages are much better than thought as well. Again, the government figures focus on the non-farm payrolls for their wage data, but with big companies, the 'traditional' hirers for many workers, laying off workers and increasing productivity, wages did not grow. The government cannot accurately measure self-employed workers wage growth, however, so it has no real idea whether wages are growing for all of the new businesses spawned by the tech boom to bust plunge. It has thus grossly misjudged the strength of the US worker/entrepreneur.

The empirical evidence shows it did just that. The housing boom attests to the incomes and optimistic views of US citizens. Spending and consumption boomed. Business investment boomed as those hundreds of thousands of new businesses bought capital equipment, aided by the much more generous expensing options contained in the Bush tax cuts. If wages are low and the outlook for jobs and income are poor, consumers don't spend. The data rebut that emphatically.

In sum, the jobs data is closely watched and is great political fodder. It does not tell you about the current economic strength, however, nor does it even accurately measure jobs in the modern economy. Futures were up on Friday after the jobs report. Whether they can hold over to Monday remains to be seen, but it is rather false optimism; things were good enough to hire more workers, but as we know, CEO confidence also lags the economic cycle, missing the tops and the bottoms.

By: Jon Johnson, Editor

Jon Johnson is the Editor of The Daily at

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