Financial Sense   Home  l  Market Monitor  l  Market WrapUp  l  Storm Watch  l  About Us  l  Contact Us

Money, Money, Money

Overall market volatility has been quite low so far through today’s trading. Stocks, bonds and the dollar began the day with modest gains driven by favorable revisions to the first quarter GDP Report. On May 26^th the Commerce Department estimated first quarter GDP at 3.5% growth, but today gave their final revision showing the growth rate at 3.8%. Stocks benefited from the revision to higher growth, and in like manner U.S. Treasury notes and bonds caught an early bid when the GDP price index was adjusted from an inflation rate of 3.2% down to 2.9%. The U.S. dollar has been mixed versus the major currencies with the Canadian dollar gaining ground, the yen and pound lower, and the Swiss franc and euro basically flat. After a few flurries of activity in the morning, the markets now look like they are in a coma as we wait for the rate announcement and accompanying statement from the Federal Reserve tomorrow.

It is typical to see low volatility as traders attempt to square their positions in front of the Fed’s announcement tomorrow, but I have said before (like a broken record) that we usually see very low volatility on days the U.S. Treasury is conducting debt auctions. Today the Treasury plans to sell $20 billion in two-year notes…that should say it all. In pre-auction trading the notes yielded 3.62%, which is not too bad for two-year paper when we consider the yield on ten-year Treasury debt is only 3.97%. The auction should have good demand today, but please note how the yield curve continues to flatten. The yield spread between two-year and ten-year is only 35 basis points, and I believe the spread will tighten another 10 to 20 basis points, but I don’t believe the Fed wants to invert the yield curve. The flattening yield curve clearly portends an economic slowdown, and according to Bill Gross we now have a higher probability of seeing a recession. He sees roughly a 10% chance the U.S. goes into recession this year and a 20% to 40% chance we go into recession next year.

It looks to me like the Fed wants to see slower economic activity. By raising interest rates they are working to make the dollar more attractive as the Fed pretends to fight inflation while the government continues to manage inflation figures lower. (See Jim Puplava’s piece on “The Core Rate” for details on the history of the government’s statistical changes for inflation figures, and why.) Higher rates should also work to slow consumption here in the U.S. thereby reducing our trade deficit. A slower economy will also put less upward pressure on commodity prices as global demand remains high. The Feds have been ramping the money supply in an effort to keep paper asset prices inflated, but continue raising interest rates to slow consumption and strengthen the dollar in front of a possible revaluation from China. I expect the U.S. Dollar Index to touch the low 90’s, then remain range-bound between 80 and 90 until we reach the dreaded revaluation from China.

Aside from the final revisions to first quarter GDP, the only other significant piece of news that affected the financial markets today was the inventory report from the Energy Department. Most analysts expected modest declines in crude inventories, but the government reported a build of 1.1 million barrels and the American Petroleum Institute said there was a 2.9 million barrel build in crude stocks. Distillates were expected to show a build of 1.1 million barrels, but the inventories actually grew by 1.7 million barrels. With the announcement, crude moved to a low of $56.90 a barrel and ended the day down $.94 at $57.26 a barrel. August natural gas closed a penny higher at $7.09. Natural gas is one of my favorite investments (trades) for the second half of 2005! After the run from $6.25 to 7.90, I’m watching gas closely to see if this retracement to $7.00 will stick. The fundamentals look good.

Quarter Ending for Stocks Tomorrow

The good news on revisions to GDP and higher than expected oil inventories helped stock prices today, but the Dow Industrials are showing signs of fading as the day progresses. Candidly, I’ve been stalking the market in search of the right entry point to short the broad stock indices. I believe stocks are being held up for window dressing to close the second quarter when tomorrow’s trading is done. I also believe the stock bulls are waiting to see if the Fed softens its stance on “measured” rate increases. If the Fed backs off tomorrow with regard to future increases, stocks could get a nice bounce. I’ll be waiting to see how the dust settles before entering my short position. The other item I will watch closely is mutual fund inflows at the first of the month, as money is typically deposited into IRA’s on regularly scheduled monthly contributions.

Earnings season is now upon us, so shortly we will see who is making their numbers. The report from Monsanto today could be indicative of what we will see as we move through the earnings season. Monsanto reported sales higher by 22%...nice gain, but net income took a big hit. Last year the same quarter came in with earnings of $.93 and Thompson First Call estimated this quarter at $1.01, but the company only reported net income of $.17 per share after one-time write-offs. I expect to see more companies with good top-line sales, but with increasing costs they won’t be able to translate the sales gains into profits on the bottom line.

By the end of today’s trading the Dow Industrials fell 31 points to 10,374 and the NASDAQ Composite was down one point to close at 2,068. The broader market didn’t do much today, but I found the precious metals mining stocks of particular interest. July silver settled at $7.057, down $.039, and August gold settled at $438.60 for a gain of only 90 cents, but look at the mining stocks as measured by the gold indices. The HUI (unhedged miners) added 8.68 to 203.10, a gain of 4.5% and the XAU (with some big hedgers) added 3.45 to 94.55, a gain of 3.8%. With any decent follow-through tomorrow, the stocks are telling us the correction in the metals is nearly complete. Keep an eye on the HUI/Gold ratio, as a breakout in the ratio can act as an early head’s-up for a breakout in the metal. Continuing turmoil in the dollar, euro and yen will bode well for gold through the second half of the year.

Global Slowdown and Housing

We are beginning to see more signs of global slowing. Germany’s DIW Institute lowered its GDP forecast for the balance of this year from 1.8% growth to only .9% and also lowered the 2006 forecast from 2.0% to 1.5%. In the U.K., retail sales took their biggest one-month hit in the last 22 years with the CBI Retail Sales Index falling to -19 from -7 the prior month. In Japan, the yen fell to an eight-month low against the dollar and dropped versus the euro after a government report showed Japan’s industrial production fell in May. Even more ominous is the current developments in the real estate market in England.

Bank of England Says Lenders Face Higher Risk of Debt Default

June 27 (Bloomberg) -- U.K. banks face increasing risk that consumers and companies will default on debts, the Bank of England said. 

In its semi-annual Financial Stability Review published today, the central bank said record household debts totaling more than 1 trillion pounds and "continuing rapid lending growth" leaves banks vulnerable to any sudden slowdown in the economy.

Consumers have become more reluctant to spend and less able to service debts as the Bank of England has kept its benchmark interest rate unchanged at a 3 1/2-year high of 4.75 percent for 10 months. Lloyds TSB Group Plc, Barclays Plc and HSBC Holdings Plc said bad consumer debts and weaker lending had eroded profits this year. 

"The high levels of indebtedness of households and firms continue to point to medium-term vulnerabilities," the report said. "Unexpected periods of economic strain could precipitate tighter credit conditions and repayment problems."

Now I’ll follow the possible debt default problems in England to a broader global perspective thanks to a recent posting in Robert Chapman’s International Forecaster:

Wednesday brought new life for Fed market manipulation. They added $6.25 billion in repurchase agreements causing the repo pool to rise to $79.059 billion.

We have witnessed the fastest, longest, priciest real estate market in history worldwide due to low interest rates and reduced regulations. This bubble is what has supported the world economy since 2000. Residential property in the developed world has risen by $30 trillion to $70 trillion over the past five years. This bubble is larger than the stock market bubble of 1929. When the bubble breaks, and it must break, it will be the biggest financial collapse in history. There are 10 major countries where house prices continue to rise more than 10% annually. US prices are up 12.5% with Washington, DC, Florida, California, Hawaii, Nevada and Maryland up over 20%. In Europe, Spain and Ireland have similar gains. France is up 15% and Sweden, Denmark, Italy, Belgium up over 9%. The Australian market has broken with virtually no gain this year and Britain is only up 5.5% in the first five months of 2005. British prices have fallen ten months in a row. These, as we reported earlier, were the weakest numbers since 1992. We in America are usually six months to a year behind the UK markets. The UK has a crisis of confidence regarding appraisals and sales have fallen 30%, which is the mark of a market in denial. It may be of interest to you that during this five-year period prices have fallen in Germany and Japan.

America’s ratio of house prices to rents is 35% above the average during 1975-2000. In comparison, England, Australia and Spain are overvalued by 50%. In order to reach equilibrium, rents must rise or house prices must fall or both.

The American market is driven by interest-only loans and adjustable rate mortgages. Thirty-six percent of purchases are for investment or are second homes. Forty-two percent are first-time buyers, and 25% of all buyers made no down payment on their home purchase last year. In the hot areas in the US, 52 to 64% of mortgages are interest only or adjustable.

The Netherlands, Australia and England have cooling markets and it is only a matter of time before the US, Ireland and Spain follow. Sooner or later first-time buyers will be frozen out of the market and that will spell the end of rising prices. In San Diego only eight percent of borrowers can qualify for a first time 30-year fixed rate loan because prices are so high. Real estate is certainly a very risky market at this juncture.

Mortgage rates are historically VERY low, but mortgage activity is clearly slowing. The Mortgage Bankers Association said their applications index fell 1.1% with refinancing down by 1.8% and the purchase index down by 0.4%. The 30-year fixed rate dropped from 5.63% to 5.47% and the average one-year ARM fell four basis points to 4.42%. These are the lowest rates since March 2004, but I’m still waiting for the 4.99% 30-year fixed that we saw in May of 2003. I’m beginning to doubt if we will see mortgage rates go deep enough this year to kick-in another round of refinancing, but if Mr. Gross is correct about a recession next year, maybe we get 4% forty-year mortgages to keep the party going!!

For now, all we can do is wait to hear what the Fed has to say tomorrow and how the markets react to every word in the prepared text. The markets have been “largely in measured conundrum with irrational exuberance remaining equally balanced” as the Fed would say. Let’s see if tomorrow’s text introduces any new vocabulary to the American public that is sure to be regurgitated over the ensuing weeks.

Frankly, the only real conundrum we all truly face is money itself. What is money? What characteristics does good and honest money have compared to the fiat money we use today? We try to value assets in terms of how much money things cost, but the value of money keeps changing. Are prices really moving higher, or are the fiat monies around the globe falling in value? We are not going to get a handle on the stock, bond and commodity markets until we get a better idea of how much money is going to cost around the globe, and how much more money governments around the world decide to create out of thin air. Ask yourself if understated inflation is a hidden cost to holding U.S. dollars, or any other fiat money for that matter. What is money? How do we put a value on money? We all want more of it, but very few people are able to define money and the characteristics it must poses to be considered honest money. Which money is the best one? You make the call!!! When you figure it out, go buy the best money!

Have a Great Evening!

Mike Hartman

Home  l  Broadcast  l  Market Monitor  l  Storm Watch  l  Sitemap  l  About Us  l  Contact Us