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ISM Report Trumped by Energy Storms and Layoffs

In May the ISM Services Index was reported at 58.5 and expectations called for the June number to come in at 58.7, but growth in the service sector came in at 62.2. After solidly beating expectations, I expected the announcement would send stocks notably higher along with the U.S. dollar, and see bonds decline with the better than expected growth…not so!! In fact, just the opposite is happening. With about two hours left in the trading day, the Dow Industrials are down 39 points, the dollar is slightly lower and bonds are catching a bid thereby pushing interest rates down. Rising energy costs are weighing heavily on these markets, as supply concerns for the second half are being complicated by storms in the Gulf of Mexico.

Natural gas has risen for a third straight day from opening at $7.02 last Friday to today’s intra-day high of $7.70, crude is back above $60 a barrel, and unleaded gasoline is going through the roof. Unleaded opened Friday at $1.58 a gallon and closed above $1.79 today, a nifty, three-day gain of 13%! Tropical Storm Cindy brought heavy rain and 60 mph winds to the Louisiana coast and forced some oil and gas companies to evacuate workers and curtail production. Tropical Storm Dennis is expected to become a category-three hurricane, and is headed directly for the Gulf Coast. High energy costs are working as a tax on the global economy causing stocks to think again about economic growth moving forward. Higher bond prices are pointing to an economic slowdown caused by rising energy prices. Note that oil is back above $60 a barrel with the dollar also strong…this means the rest of the globe just got hit even harder with crude over $60. Crude at $70 or $80 a barrel sure looks real for the second half of the year.

Also weighing on the markets today was the report from Challenger, Gray & Christmas as reported by CBS MarketWatch: “The U.S. automotive and retail sectors slashed tens of thousands of jobs in June, bringing the number of planned job cuts to 110,996, the highest in 17 months, according to outplacement firm Challenger, Gray & Christmas. Corporate announcements of job reductions increased by 35% from May’s 82,282 and by 73% from June 2004’s 64,343, Challenger said Wednesday. Cuts are up 92% since April.” This negative report from Challenger is an early head’s-up to watch for the June jobs number to be reported Friday morning.

Actually, the layoff numbers just reminded me of something I read from the King Report last night. “The most important weekend business story that we saw appeared in The Chicago Tribune on Saturday. The article, “Small-business gauge tumbles to 8-year low – Index down steadily since high in 2000” refutes the BLS’s Net Business Birth/Death Model job creation and all those Wall Street gurus that prostrate themselves before government economic data.”

Mr. King has presented a very solid case in his past postings that the job creation numbers have been consistently overstated in government data. I somehow suspect the numbers on Friday will disagree with the Challenger report, but take it with a grain…we live in an era of managed markets and managed data. It is interesting to see some of the comments about phony government data hitting the mainstream press. With thanks to Bill Murphy for catching this one in yesterday’s Midas:

From Alan Abelson, Barrons, July 4, 2005 

"Sometimes perusing the handiwork of this nation's worth number-crunchers we get the feeling we're not in the good ol' USA but in the Soviet Union, circa 1970....WE experienced it again last week, on receipt from some eagle-eyed readers of the results of their close reading of the final version of the first quarter GDP...The difference between the 3.5% preliminary rise reported for GDP and the final 3.8% released last week is, even by our shaky math, 0.3%. As it happens, that also was pretty much the amount by which the official inflation measure, the GDP implicit price deflator, was revised downward, to 2.89% from 3.16%. 

OK? What caused the big drop in inflation, and hence the rise in GDP was ....housing. We kid you not. According to the BEA, housing prices, which they figure rose at 5.4%, 9.1%, 6.8%, and 3.8% annual rates respectively in the last four quarters of '04, fell to a 1.1% rate in the first quarter of '05. Funny, we had the impression that housing in January-March was on fire, and prices more than rising apace. Not so, say the lads and lassies at the BEA. They do concede that spending on housing was up a robust 11.5% in the quarter. But prices were up a meager 1.1%. Come on comrade, tell us another. Or better yet, tell anyone who bought or sold a house in the first quarter. The buyers, anyway, could use a good laugh."

So now we can see the adjustment to move GDP higher was nothing more than pure inflation…no real growth. Maybe that’s why the markets didn’t react to the strong growth number from the ISM report. Maybe oil WILL go to $80 and the Fed will keep raising interest rates. The CPI has already been muted to show “low inflation” and most recently the calculations have been changed to mute the rise in the CRB Index. If you would like to see some of the details surrounding the changes to the CRB, please read Ed Steer’s “A Eulogy for the CRB.”  Mr. Steer opens his essay with, “In light of the deliberate disinformation coming from within the American government regarding the Consumer Price Index (CPI), the Producer Price Index (PPI) and the (un)employment statistics from the BLS; it should come as little surprise to anyone that one of the most watched benchmarks that highlights commodity prices is about to be radically altered. This benchmark is the CRB.” 

It is clear to me that our growth is overstated because inflation is clearly understated. The dollar has been in rally mode because the big spin on Wall Street has the U.S. economy growing faster than the economies of other countries around the globe. I would say the U.S. is better at inflating the economy (asset prices) without showing any consumer inflation than all the other countries around the globe. As long as the new money creations show-up as asset inflation (higher stock, bond and real estate prices), everyone is happy. When the new money shows up as higher consumer inflation, all the red flags go up in the air…that’s why high energy costs are not inflationary…they have spun the oil increases as deflationary by being a drag on the economy.

Now let’s take a quick look at the asset inflation in the real estate markets. According to the Mortgage Bankers Association, mortgage activity is on the rise once again. The MBA reported its applications index rose 9.6% with the purchase index higher by 9.1% and the re-fi index up by 10.2%. The 30-year fixed rate gained 11 basis points to 5.58% and the average one-year ARM moved up 18 basis points to 4.60%. Overall activity in real estate still remains quite brisk as reported on U.S. Newswire this morning:

“WASHINGTON, July 6 /U.S. Newswire/ -- The Pending Home Sales Index, the leading indicator for the housing market, slipped from near-record levels but remains historically high, according to the National Association of Realtors(r).

The Pending Home Sales Index, (see note 1) based on data collected for May, stands at 124.9, which is 2.0 percent below April but 3.7 percent above May 2004. April's downwardly revised reading of 127.5 was second only to a record of 128.1 in October 2004.

The index is based on pending sales of existing homes, including single-family and condos; a sale is pending when the contract has been signed but the transaction has not closed. Pending home sales typically close within one or two months of signing.

David Lereah, NAR's chief economist, said the index shows robust home sales can be expected for June and July. "Pending home sales are at the third highest on record, so we're looking at a banner year for the housing market," he said. "To put the index in perspective, we're running about 25 percentage points higher than what is considered to be historically strong." April and May were the highest months on record for existing-home sales."

In the earlier quote from Barron’s we learned the first quarter GDP numbers were adjusted higher because housing prices were adjusted lower to show the growth in home prices of 1.1% for first quarter 2005. Clearly the government’s numbers are in disagreement with the NAR…seems to me the government’s data should be called into question. The discrepancies can only be justified by the fact that we are at war. Our enemies want to take us down economically, therefore the U.S. authorities feel justified in distorting the data…it’s that simple! We are fighting to maintain the single reserve currency of the world, while others would like to see the U.S. dollar knocked off its pedestal. All is fair in love and war???

Wall Street begins earnings season tomorrow when corporate results for the second quarter start hitting the newswires. The pressure from high energy costs is still outweighing the growth in the ISM numbers. By the closing bell the Dow Industrials fell 101 points to close at 10,270 and the NASDAQ Composite dropped 10 points to 2,068. Unless we can get a few leaders with good earnings reports in the next day or two, I don’t see stocks moving higher over the near-term. If we get any kind of blow-off top through earnings season, I will use it as an opportunity to short stocks; otherwise I’ll stick with making money in the commodities arena!

Back to the Dollar

I said earlier the dollar has been in rally mode because Wall Street is spinning U.S. economic growth as stronger than our biggest competitors, but we have kept our asset prices high with continuous money pumping from the Fed. We have growth because of inflationary stimulus, primarily from credit growth because of artificially low interest rates. I believe this dollar rally is getting a bit overdone when we stop and take a look at the fundamentals. How much longer can we continue borrowing our way to prosperity?

From “The Road to Destruction” by James R. Cook:

“You can continue to believe the wizards of Wall Street and Washington, who claim their inflationary brew will perpetuate prosperity, or you can listen to the classical economists who have combined the lessons of history with the basic principles from two centuries of sound economics. Whether you choose to listen or not, be assured that the following inevitable consequences of inflation will cloud your future; an ongoing financial and economic crisis, moral and cultural disintegration, stagflation, bigger government, escalating hatred of business, runaway social spending, the criminalization of success, higher taxes and a shrinking dollar. Somewhere out there lies complete and total collapse. That utter collapse is coming as surely as the sun will rise tomorrow and the government will keep inflating until the bitter end.”

      "The damned Fed is creating as much money in one lousy quarter as they averaged in a whole year in the 90s!" Mogambo Guru - editor

"Bank credit expanded an amazing $1.054 trilling during the quarter to $7 trillion. That was a growth rate of 13.4%." Doug Noland - economist

"Boatloads of credit are being created outside the banking system. Much of it destined to fund second homes in Vail." Rob Peebles -analyst

In terms of credit growth, this is the greatest inflation orgy in history." Dr. Kurt Richebacher - economist

"The only thing I'm completely confident of is that the end result of this irresponsible money-printing by the Fed, lending by the financial institutions, and behavior on the part of the public will be a tremendous amount of pain for everyone." Bill Fleckenstein – editor

We have seen monetary aggregates explode at historically unprecedented rates. The dollar has rallied well off its lows, but I insist the fundamentals will again re-assert themselves. A weak jobs report on Friday or declining stock prices could well be the catalyst for global investors to see the house of cards we have built out of the fiat dollar. Bryant Blake, a contributor to LeMetropole Café had this “nutshell version” of the dollar fundamentals:

“The U.S. Federal Debt just rocketed 60 billion in one day to $7,836,495,788,085.86 on 6/30/05. This puts the fiscal year deficit at $457,443,091,755.54 since 9/30/04. The administration’s proposed budget deficit for FY 2005 was only $427 billion. They have now exceeded that amount and it is only 274 calendar days into the fiscal year. At this rate, the Federal debt will increase over $609 billion in FY 2005. But it gets worse than that for tax payers and better for gold currency advocates. The U.S. Office of Management and Budget projects that $186 billion in excess social security payments will be applied to the budget deficit this year. Hence, at the current rate, the true budget deficit for FY 2005 will exceed $795 billion. This is over $66 billion dollars per month and represents an annual increase of 10.78% in the debt. Combine this with the trade deficit, and the red ink is nearly $130 billion per month. I don’t know the exact numbers, but this is close to $1000 per month, per full time employee in this country. This house of fiat is built on sand!! Thanks for your perseverance, and unflinching optimism based on the fundamentals.”

Our country is currently engaged in war. Most of us saw fireworks over the weekend for the Fourth of July Holiday, but please remember we took the day off work because our country won a war. The fireworks were a re-enactment of the bombs bursting in the air. When I saw the fireworks going off over Windsor Lake just two days ago, I asked myself if all the people around me realized how very serious the threats are against the USA. The Cold War never ended…it continues to this day. We don’t get to see any of our dead soldier’s bodies come back from Iraq because of the mandatory censorship (management) of the news. I believe most Americans are living in denial. As wars around the globe escalate, ask yourselves if we will be celebrating victory with fireworks as we did Monday night, or if there is another possible outcome. For now, when you see one of our soldiers, throw him or her a high-five and THANK THEM ALL for their service to our freedom.

Pray for our country and our leaders. May Peace be yours!

Mike Hartman

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