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LOOKING FOR DIRECTION

The markets were quiet today. Overall, stocks floundered around break-even for most of the morning but moved higher in the last hour of trading, Treasury Bills, Notes and Bonds were slightly positive, the dollar was fractionally lower versus most major currencies, and precious metals/commodities were mixed but mostly muted with movements up and down within two percent from yesterday’s closing numbers. It sure feels like we’re drifting through the beginnings of the summer doldrums. It’s tough to make any money when there’s no volume and volatility is nonexistent. You traders out there are chomping on the bit to see something happen! Probably the biggest event of the day was the auction of a fresh $25 billion in two-year Treasury Notes that saw better demand than expected. The bid-to-cover ratio for the auction was 2.17 to one, which indicates a fairly healthy demand for the Federal debt paper.

The yield for the two-year notes went off at 2.72%, still a negative return after taxes and inflation, but this paper serves more as a “parking place” for some of the big money. Many onlookers were watching to see how the participation came in from foreign central banks. As it turns out, foreigners bought roughly $15 billion of the $25 billion auctioned. On T.V. they were calling it a “match made in heaven”…with American’s appetite for foreign goods remaining strong and foreigners jumping right in to buy our Treasury debt. More than half of our federal debt is owned by foreign countries and today they bought about 60% of the offering, and it’s a good thing they keep on buying because otherwise rates would be noticeably higher. Market commentators are saying the demand from offshore is positive because many analysts were wondering about whether foreign cash would continue flowing into the auctions with the Federal Reserve looking like it will raise the discount rate in a week and an overall expectation for higher interest rates pushing bond prices lower. So far so good…they were buying today! Now we will have to watch and see if Mr. Bush will need to ask Congress for permission to raise the Federal debt limit before they get to the November elections. I sure wish he had to do it formally, because that would be the icing on the cake for a lower dollar.

Also on the interest rate front, the Mortgage Bankers Association announced today that 30-year mortgage rates dropped slightly last week from 6.34% to 6.21%. My best guess says that we would have 8% mortgage rates if foreign central banks had no interest in buying our debt paper and supporting the dollar. The MBA also reported the Purchase Index higher by 1.1% but the Refinance Index falling 1.7%. The refinance share of mortgage activity decreased slightly to 33.4% of total applications. Credit is still flowing freely as the Fed makes very sure they will err to the side of inflation with easy money policies.

Oil, Gold and Commodities

Crude oil came under some pressure today after the Energy Department reported higher than expected inventories with a build of 2.5 million barrels while expectations called for a build of only a million barrels. August crude settled at $37.57 per barrel, down $0.68 for the day. Just remember $37.00 crude is still relatively expensive in the big picture since we were paying less than $15.00 in 1998-99 and even as recently as 2002 it was below $20.00 per barrel. With energy costs moving consistently higher, we are in an environment of inflation…higher energy costs push prices higher throughout the system just as a basic cost of doing business from air conditioners through transportation.

After pushing the two-year Treasury debt out the door today, the dollar barely budged. The U.S. Dollar Index closed very slightly in the red at 89.73. To confirm a resumption of the downtrend in the U.S. dollar, I’m looking for a close below 88.40…that’s when gold should take-off again. June gold didn’t budge a bit with a close of $395.00, the same as yesterday and probably won’t take out $405 until we get past the Fed announcements on June 30^th. Silver followed suit by adding only one penny to the July contract with a close of $5.875 per ounce. It certainly looks like the worst of the correction is over for gold and silver. Now we just have to get through the next meeting of the Federal Reserve at the end of the month to see the dollar move lower and watch gold and silver move higher after building their bases to take out $400 and $6.00 respectively. Once the market sees that Greenspan is going to move in slow motion with quarter-percent moves in the discount rate, money will gradually slide back into Treasuries, the dollar will resume its downtrend and gold will move higher as it prices-in inflationary expectations.

Stock Action

The stock market went blasting out at the highs for the day. It all happened in the last hour with the Dow Industrials at 10,479, up 84 points for the day. The S&P 500 closed higher by nine points to 1,144 and the NASDAQ Composite moved 1.3% higher to close at 2,020. Playing the broad stock indices has been about as exciting as watching the grass grow. Since early December the Dow Industrials has gone from 9,850 to 10,750, a 9% range for a seven month period, and recently we’re stuck in the middle of the range. In the last eleven trading days the Dow has only moved 1.2% from 10,315 to 10,479. The bulls are calling this a break-out day with higher levels to come, but I’m not convinced yet.

The Dow Jones Transportation Index was one of the top movers today with a great report coming from Federal Express. The company announced fourth quarter profits rising by 47% as an expanding global economy boosted demand for shipping. That’s where I have to take pause by saying that we’re in a confirmed global expansion, but just how much will the U.S. economy benefit from the global boom? I’m afraid our excessive debt levels, high cost of labor and the low utilization rate of productive capital will keep us from enjoying all the benefits of the growing global economy. Japan and China appear to be in a better position to grow with the global expansion. We will grow with inflated dollars that don’t buy as much. Keep the Dow at 10,000, but watch the dollar drop another 20% over time for a loss of at least 50% from its peak purchasing power. We could have the same dollar with the Dow at 5,000 or half the dollar at Dow 10,000…it’s all a wash in the long run, and that’s what you’re watching in today’s markets.

I prefer the short side of the stock market, because the downside risk weighs greater than the upside potential. In the near-term, however I don’t see a crash in store unless we get some kind of external terrorist event. We could easily see stocks remain range-bound until we get to the elections. In the meantime, Mr. Bush will have his work cut out. He’s taking some serious heat for the prisoner abuse scandals by allowing torture and he might really need the private attorney he has retained to get him through the problems of the Valerie Plame leak. If Mr. Bush knew about the disclosure of Ms. Plame’s identity as a deep cover CIA operative, his offense is impeachable. There are a whole lot of muscle moves going on behind the scenes than meets the eye. It looks like Mr. Bush made some of the wrong people very mad, to the point he could be eliminated from the elections in November. The main stream media is already proposing the uncertainty of a new executive staff. The way it’s shaping up, Bush probably won’t see a second term. As always…time will tell!

Have a great evening.

Mike Hartman

Chart courtesy of StockCharts.com

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