Last Week’s Highlights:

Stocks:                                13K doesn’t hold – AIG loss dampens pricing

VIX:                                   Stock volatility low – VIX at 19

Bonds:                                Yield stable near 3.75% - Curve slope +155

Oil:                                     $125 and counting

Regular Gas:                      $3.61 (CA high at $3.80)

Dollar:                                Strength holding at 1.54 euro

Economics This Week:

Date       Item                     Est.                       Comment

5/13       Retail Sales           Unch                    Flat

5/14       CPI                      0.2/0.3                  All measures up – overall north of 4%

5/16       Housing Start       950K                    Down from April

Recession Averted?

With Q4 2007 and Q1 2008 both showing 0.6% increases in GDP, there are many on the Street now suggesting the US economy has averted a recession, but only by the skin of its teeth. While some sectors of the economy have clearly been in recession for some time, such as housing and now the financial industry, other drivers of GDP appear to be holding up well and are expected to firm as we go through the second half of the year. First, as we have been talking about in the report for months, the export component of GDP continues to be a very strong engine. The weaker dollar and reasonable growth in foreign economies has been keeping this component alive and well. Consumer spending has also been doing its job despite some slow down and less than spectacular confidence levels. Another surprise has been stable business investment growth. Finally, government spending, which accounts for about 20% of GDP, keeps moving forward. So far, the combination of these factors has been enough to overcome the drawdown from the residential (housing) and investment portion of GDP.

Source: Bureau of Economic Analysis

Should we count this economic slowdown as over? Maybe not just yet. I ask this question to industry specialists every opportunity I get.  This past week, I had an interesting conversation with a very successful real estate development and investment manager. His outlook was not so optimistic. He thinks residential housing won’t see the bottom until mid-2009, based on pipeline inventory and sales forecasts. This person happens to be based in the Miami area which is, of course, one of the hardest hit in terms of inventory build up, declining home sales prices, and foreclosures. By his own admission, his local view has significant influence on his national view, but that’s always the case. One doesn’t have to go back too far to remember the Internet bubble burst and what that did to the communities around San Francisco. Folks in those areas often described it as a depression, not a recession.

Car Pooling Anyone?

Crude is now holding above $125 per barrel, and gas is on track to hit $4.00 per gallon by the peak driving season in the next few months. Some are already calling for $5 gas by year’s end if oil continues its current trend. The lift in gas, and especially diesel (now $4.20 per gallon) will only contribute to a further decline in our discretionary income over the next few months. At some point – though we’re not there yet – we’ll all reach our toleration point at the pump. Right now the economy is limping along, but employment is holding up reasonably well. However, if the economy continues to falter we will quickly change our spending habits, as we always do. We are a very adaptive lot and when we get to our breaking point, we react.  That will mean less car travel, less discretionary spending, and a “hunker down” mentality. This is exactly what the economy and the financial markets don’t need and can’t afford.  Even big rate cuts and fiscal stimulus will have trouble in this scenario.

And speaking of fiscal stimulus, seems like that nice rebate check from Uncle Sam some of us will soon be getting will simply go back to the gas pump rather than to savings or retail spending.  Seems odd to me that we have to raise capital via Treasury bond issuance (bought mostly by foreign buyers like China) to pay for a rebate that then gets sent back through the energy supply system to the Middle East.   I’m still thinking that a holiday gift card, good at any store in the US, valid through August 08’, would have been a better solution – it would have ensured that the rebate check was spent on economy-stimulating “consumption”.  And, of course, in the wisdom of Washington we have a new bill underway in Congress called the “Consumer First Energy Act.”  With a nice name like that you’d think it was a coordinated energy policy plan that seeks new oil fields and alternative energies to help the economy right? Wrong ! 

The bill is designed to penalize the oil companies by charging a 25% windfall profit tax and a roll back on tax breaks. Am I completely mad or is there something wrong with trying to penalize the companies that are in business of delivering energy?  One would think we would be doing everything we could to encourage these firms – and all our technology firms – to find energy sources outside the Middle East, say in the US for example. It’s too bad because, from my read, there’s nothing in the bill to help our energy situation --only a short term tax penalty to a few very big, very capitalist companies. 

Source: EIA

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