Last Week’s Highlights:
Stocks: Big swings, starts week in positive mode
VIX Holding at 21
Bonds: 10-yr correction to 4.25%
Oil: $135 and steady
Regular Gas $4.03 national avg.
Dollar: Dollar gains - 1.54 Euro
CPI 4.1% and rising
Retail Sales 1% - A surprise lift
Economics This Week:
Date Item Est. Comment
6/17 PPI 1.0%/0.2% Overall reaching beyond 7%
6/17 Housing Starts 1000k Slight up-move seen
6/19 Leading Indicators 0.1% Near unchanged
The String of “4s”
It struck me as quite coincidental that last week there were a series of “4s” that played an important part of the market. First, of course, was the $4.03 new record high in retail gas although it’s more like $4.15 in most metro regions. The second “4” was the 10-yr Treasury bond yield which ended the week just north of 4.25%. And last, was the year-over-year CPI rate that came in at a hefty 4.1%. I can say that “4” is not my lucky number at the moment.
“4” #1 – Retail Gas at $4.03
Gas topping the $4 mark in a big way is now pretty much old news. Not only are analysts suggesting that $5 gas might be in the works this summer, but diesel prices are really already there. There are however, a number of people on the Street thinking a bubble in oil may be coming. This bubble, most likely a technical one as opposed to a fundamental change in oil demand, could be burst by the “spec” traders. As we all know, the inflow of money to the commodities markets - and especially the oil markets - by speculative/momentum traders is off the charts. That’s the bad news and the good news.
Bad, because it has been one of the catalysts that has propelled crude and gas prices to the levels we see today. Good, because with any momentum trade, there ultimately comes a reversal. The tech folks point to the increase in oil price volatility and the big price swings we have seen (+/- $10 in two weeks) on what we normally would consider minor news. Once a market price plateau is established, there will be a large number of itchy investors with significant profits. Don’t forget that in just 12 weeks, oil has risen over 35%. That’s a tidy gain not to be lost on a swing lower. If you are looking for a place for the market to surprise and move against the daily news channel wisdom, this could be it. If oil corrects back just a bit, it could be enough to get gas back below $4 and decent sentiment for better summer stock returns. Ok, that’s the best I could do for a positive outlook on oil!
“4” #2 – 10-yr Treasury 4.25%
The next big four has been in the bond market. After months of yields on the 10-yr trading at a very low 3.5% range, conditions have changed dramatically. The 10-yr now sits at 4.25% and appears poised to move even higher. Why? The answer is simple – bond players have now agreed that any further Fed easing is all but done. With only tighter monetary policy ahead, the big “flight to safety” bond trade is now over and profit taking is underway. In anecdotal conversations last week, I had three bond managers suggest that 4.5% by July was reality. And, if you look at the fed fund futures, you are now seeing signs of a rate hike being priced in for the Fall. A look at the chart below suggest that the current 2% funds rate is expected to end at the August meeting with expectations of a 25 bps move higher. Some are even suggesting a 25 bps hike in two weeks (very low probability). The move from easy monetary policy to a more restrictive mode is certainly underway and is being reinforced by the comments of the Fed governors. Indeed, the Fed not taking any action later this month will be the first move toward higher rates. Why? Because the Fed is now paying for its huge liquidity initiatives.
Source: Cleveland Fed
“4” #3 – CPI 4.1%
Phase one for the Fed was economic growth stability. From all counts, Bernanke may have achieved that goal with GDP bumping along in positive territory and the financial system swimming in available cash from the various Fed auction programs. Phase two for the Fed is how their liquidity impacts inflation. Just in case you were in doubt, inflation is already here. Headline CPI is now at 4.1% and PPI, due out this week, will mostly likely top 7%. These are no trivial numbers in anyone’s book. This has serious implications for the economy and of course for the markets. Don’t forget that every time inflation ticks higher, the required rate of return just to keep even must adjust as well. That being the case, the current break-even return must be near or above 5%. With the Dow down about 5.6%, the gap is over 10%. A nice Fall rally of say 15% would be nice, wouldn’t it?
Lighter Side:
Source: Internet
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