Week in Review: More Confusion Than Clarity

Includes: DIA, QQQ, SPY
by: Alhambra Investment Partners

It was a light week for economic data and what was offered served more to confuse than clarify. Market action seems to indicate that the data at this point is basically irrelevant anyway as all the market’s attention is focused firmly on the potential actions of the Federal Reserve. There appears to be a developing rift at the FOMC with Thomas Hoenig and Charles Plosser representing the sane wing and Bernanke leading the charge of the unhinged. Hoening has been the lone dissenting vote at the last six FOMC meetings but there seems little likelihood that Bernanke will be able to hold together his coalition of the printing press much longer. Rising commodity prices and a falling dollar have consequences that eventually must be acknowledged even by clueless Fed governors.

The economic data continues to present a picture of an economy in weak recovery. We don’t seem headed back to recession but it sure isn’t a boom either. Personal income and outlays were both higher in August but income rose faster than spending and the savings rate increased again. There was moderate strength in wages and salaries but government transfer receipts rose more as another extension of unemployment benefits reversed the drop in July when benefits expired. At some point - possibly after the November election - it will become impossible to keep extending those benefits. (By the way, that statement says nothing about my personal beliefs concerning whether we should extend those benefits again; it is merely a statement of fact.) It seems highly likely that the ultimate end of unemployment benefits will have at least a temporarily negative impact on income and spending.

The Goldman and Redbook retail sales reports were again at odds, with Goldman showing a healthy increase and Redbook coming in weaker. I don’t know which is correct but betting on a big increase in consumer spending at this point defies common sense. Consumer confidence remains in the doldrums and a rising stock market that most retail investors are missing seems unlikely to change that metric anytime soon. Jobless claims remain firmly in the mid 400k, anemic job growth range and it is hard to see that changing in the short term either. In fact, despite the hopes of the gridlock crowd, the mid term elections may introduce more uncertainty rather than relieving it so if that is what is driving the employment picture it isn’t about to get better. There doesn’t seem to be much common ground between President Obama and a potential Republican congressional majority.

The Case Shiller home price index showed the effects of the expiration of the home buyer’s tax credit as prices stagnated in July after rising in the spring. While many believe that rising home prices are the key to recovery I fail to see how that offers a path to recovery. We’ve got too many houses on the market and higher prices would not seem an ideal solution to relieving the market of this excess inventory. If the Bernanke faction at the FOMC gets their way and inflates further we will eventually get higher real estate prices but forcing individuals to buy real assets in an attempt to protect themselves from the predatory inflation of the Federal Reserve seems a high price to pay to bail out irresponsible home buyers and lenders.

The Chicago PMI released last Thursday offered some hope rising to 60.4 this month. New orders, production and employment all rose. Unfortunately, that report only applies to the Chicago area and the national ISM report released Friday wasn’t nearly as positive. The headline fell to 54.4 but that relative positive masked the underlying components that painted a less rosy picture. New orders, employment and backlogs all fell while inventories rose. The inventory picture continues to worsen and absent a pickup in sales seems likely to result in reduced production sometime soon. Construction spending rose in August but the gain was primarily from public construction. Private residential and non residential spending were both lower on the month and still 10% below last year’s levels.

US stocks were basically flat last week but there was plenty of action in other markets. Foreign stocks and particularly emerging markets continue to outperform their US counterparts. Thailand, India, Indonesia, Turkey and Korea led Asia higher while Brazil, Chile and Peru led Latin America to gains. Most European markets were lower although Russia, which should benefit from higher commodity prices, and Poland, which is reporting good growth numbers, bucked the trend. By the way, with everyone already on the Asian and Latin American emerging market bandwagon, it might be more profitable to take a look at the European emerging markets.

The most important trends continue to be in the foreign exchange markets where the dollar looks more and more like the wallflower at the big dance. Emerging market currencies, the resource based dollars (Australia, New Zealand and Canada) and even the Euro are all rising and apparently preferable to holding ever depreciating dollars. The dollar also fell last week against gold, platinum, nickel, tin, aluminum and probably wampum. Real estate securities are also responding to the weak dollar with international versions acting best.

I’m not sure what Bernanke and the QE II faction at the Fed expects to accomplish by further expanding the balance sheet but the mere expectation of further Fed easing has been enough to reduce the value of the dollar and raise the price of a slew of commodities. Why exactly higher commodity prices would be expected to counter the lugubrious mood of the business community is a bit of a mystery - especially when they already face increased regulatory costs - but Bernanke seems convinced that the real problems facing the US economy can be cured with monetary smoke and mirrors. I have my doubts about any beneficial effects on the real economy but make no mistake there will be effects. And I fear what we’ve seen so far - gold at $1300 and oil at $80 for example - is only the beginning.

Disclosure: No postions.