Volatility made a comeback last week as traders alternately bought and sold based on the latest utterances of various government officials. First it was Bernanke’s semi-annual report to Congress where his initial remarks were taken as an indication that QE 3 was warming up in the wings. Apparently not happy with how the market interpreted his remarks the first day, Bernanke took pains to swat down expectations the next. Next up was the dueling press conferences of Republicans and the President concerning the US debt ceiling and deficit. Republicans want fake spending cuts and real tax cuts. The President wants fake spending cuts and real tax hikes. Since the only thing they agree on are fake spending cuts, that is probably all we’ll get.
Speaking of fake, the results of the European banking system stress tests were released last week. Only a few banks in the most dire condition managed to fail. The debate over the US debt ceiling is a sideshow compared to what is going on in Europe. The bond vigilantes broadened their target list over the last two weeks to encompass Italy and faced with rapidly rising bond yields, their politicians managed to rush through a package of spending cuts and tax changes in record time.
A lot of people have pointed to low yields in the US bond market as evidence that our debt situation is not yet dire but the same could have been said about Italy not that long ago. Italian 10 year bonds were yielding about 3.7% less than a year ago and are now nearing 6%. They’re up a full 1% in just the last couple of weeks. Deficits don’t matter until, well, they do. And when they do, bond markets react rapidly and violently. Our politicians are betting that won’t happen until after they are safely re-elected but markets may yet have something to say about that. Frankly, I’d welcome a little bond market vigilantism right about now. It might help to focus the politicians on what really matters.
Stocks were down over 2% on the week and the only real surprise was that with all the negative happenings they didn’t fall further. There’s a lot out there to worry about as evidenced by the big winner of the week – gold, which managed to make new high. Keynes called gold a barbarous relic but the market is saying loud and clear that the more cruel alternative right now is a paper currency backed by nothing more than the promises of feckless politicians. Needless to say, a new high gold price isn’t good news for the economy as an investment in gold yields little in the way of productive activity. I don’t know how the deficit reduction/debt ceiling debate will come out but until the politicians do something that convinces people to exchange their gold and Treasury bills for more productive investments, the economy is going nowhere.
As for the economic data, it was another week of mixed to weak data. Given the circumstances, it is somewhat remarkable our economy is performing as well as it is. People continue to spend, companies continue to invest (albeit cautiously) and government continues to mostly get in the way. I had hoped the politicians might seize this opportunity to make major reforms but that is looking more and more like a pipe dream. And that means that, at best, the economy will continue to muddle along at this snail’s pace until at least after the next election. Of course, that assumes that nothing really bad happens in the world which also might be classified in the dream category. Europe is on the verge of disintegration, Brazil is trying to tame a credit boom and no one knows what to make of China’s potemkin economy.
The trade report showed a bigger deficit in May of $50 billion mostly due to higher oil prices. Thanks, Mr. Bernanke. Import prices are up 13.5% over the last year thanks to the weak dollar while export prices rose a more modest 9.9%. It does seem the rate of change may have peaked though as the month to month change in import prices was actually down 0.5%. Imagine what might happen if the dollar actually managed to rise.
The producer and consumer price indexes also fell last month thanks to the drop in oil prices but the core readings came in positive and higher than expected at 0.3% in both cases. One bright note, in a way, was the rise in owner’s equivalent rent in the core CPI report. Rising rents should eventually produce more home and apartment building, something the economy is sorely missing.
Retail sales were up 0.1% in June despite a drop in gasoline prices. Ex autos and gas, sales were up 0.2% which isn’t great but at least isn’t a negative number. Auto sales also rebounded 0.8% although parts shortages due to Japan still seem to be holding things up with some models – especially trucks – in short supply. Overall though sales are not rising fast enough to keep inventories from rising. Business inventories rose 1% and the inventory to sales ratio rose to 1.28 which is still low but moving in the wrong direction. Industrial production numbers may have reflected the inventory build rising just 0.2%. Most of that was due to rise in utility output (man it’s hot down here in Miami) as manufacturing remained soft. We also got the Empire State manufacturing survey from the NY Fed which was negative for the second straight month. About the only good news was that it showed a less rapid decline than last month.
Jobless claims fell to 405k but remain above the all important 400k level. I’d also point out that it was a short week with the July 4th holiday and the seasonal adjustments are weird because of the auto plant shutdowns. Normally the auto companies are just now shutting down to retool for the new model year but they shut down early this year because of the parts shortages out of Japan. That is confusing the seasonal adjustment gurus at the BLS and I have no idea whether their guesses are even in the ballpark. The job situation was probably a factor in driving down the consumer sentiment survey to levels we’ve never seen this far into a so called recovery.
All in all, a tough week. I’d recommend getting accustomed to it. We remain very conservatively invested with a large slug of cash and short term Treasuries. We also have some gold, thank goodness, and see no reason to loosen our grip on it as yet.
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