NEGATIVE ECONOMIC NEWS BODES POORLY FOR THE MARKETS

The week started in encouraging fashion after largely positive earnings reports from the likes of Alcoa and Intel.  However, the rebound was short lived after it became apparent that inflation fell and consumer confidence took a sharp turn down.  By the end of the week, the S&P 500 Index was off 1.2% and the Dow Jones Industrial Average was down 1.0%.

 

Source: Wall Street Journal

 

Small business confidence deteriorated in June according to the National Federation of Independent Business.  Buried within the report were fairly pointed remarks from the NFIB detailing small business owners’ frustration with the current state of affairs. 

 

The release stated that “while political leaders trumpet their ideological attempts to remake the economy and save small business, more and more ordinary folks are wondering what in the world are they thinking.  Either policymakers have no idea how to help the economy or they are intentionally committing it to unsustainable expenditure growth and deficits so large that there will be no alternative but to raise taxes, a slow suicide for a dynamic recovery.”

 

The NFIB went on to the say “fear is growing that the lame duck session is not so lame and could produce legislation that permanently paralyzes the economy.  Cities, states and even sovereign countries are teetering on the brink of bankruptcy while government workers and favored union workers reap benefits and wages far better than their private sector counterparts.  With an unemployment rate of nearly 10 percent, the President travels the country touting the health care bill that few like, selling wealth redistribution and the need for more taxes.  What should ordinary citizens and small business owners expect from all this?  A growing and more dynamic economy?  Not likely.” 

 

Source: NFIB

 

Echoing those concerns, small business owners chose “Regulation” as their biggest concern amongst a group of four issues.  This was last viewed as a concern in the mid-90s.  The other overriding issue facing small businesses is an outright lack of sales.  Not only is the current sales situation poor at best, but the outlook for the next three months is rather poor as well. 

Source: NFIB

 

Retail sales for June fell 0.5%, but the headline figure overstated the severity of the decline.  Weakness in auto sales and a fall in the price of gas were behind the pullback.  As the following chart demonstrates, retail sales have fallen from its recent peak, but they are still well above the trough in late 2008.  

 

Source: Dundee Wealth Economics

 

A week’s worth of disappointing economic releases culminated with a slide in Treasury yields as investors sought the safety and comfort of government guaranteed bonds. Since the start of the year, issues around the globe, coupled with concerns about the future trajectory of growth, are driving investors into government bonds, much to the chagrin of pundits who thought this would finally be the year that the government bond bubble would burst.

Source: Haver Analytics

WHERE, OH WHERE, IS OUR INFLATION?

Last week’s reports on the Consumer Price Index and the Producer Price Index only served to confirm what everyone already knows – any discussion of budding inflationary pressure is naïve at the moment.  

 

At the consumer level, CPI fell by 0.1%, representing the third consecutive month of decline.  Excluding the volatile food and energy component, prices were up 0.2% last month and are now up 1.0% year-over-year.  

 

Source: Federal Reserve Bank of Cleveland

The Federal Reserve Bank of Cleveland’s preferred method of inflation, which excludes volatile outliers on a monthly basis, is tracking at an even weaker pace over the past 12 months. 

Producers did not fare any better in the month with a 0.5% drop in the PPI.  It was a similar story as food and energy costs were the biggest contributors to the decline.   

Source: Econoday

 

As both reports show, it is too early to write off a full blown deflationary episode.  In addition to weakness at the consumer and producer levels, the rate at which money changes hands (a common means of inflation) is near its slowest pace in years.  Other problems facing the US, indicated on the following graph are a rising personal savings rate and ever slower demand for commercial loans.

 

Source: Knight Research

 

Even the Federal Open Market Committee is ratcheting down expectations for inflation through the rest of the year, dropping the estimate for Core Personal Consumption Expenditures Inflation for 2010 to a range of 0.8% to 1.0%.  Tepid demand at the consumer level will weigh on inflation throughout the rest of this year at the very least, while producers’ margins will remain tight due to their inability to pass on higher energy costs to the end users. 

THE WEEK AHEAD

Earnings season begins in earnest this week with several hundred companies set to report.  The list of notables includes IBM, Johnson & Johnson, Goldman Sachs, Apple, Yahoo, Morgan Stanley, Starbucks, 3M, Caterpillar, Nokia, Amazon and Microsoft. 

 

Economic data this week concentrates on housing with the release of housing starts, existing home sales and the FHFA home price index.  Without the government lifeline, the housing markets are floundering and there is no reason to believe that we will see a reversal of that stance.   

Federal Reserve Chairman Bernanke will testify before lawmakers on Wednesday during the semi-annual monetary policy address.  Bernanke will discuss the state of the economy and where the Fed expects us to go from here. 

 

On Friday, the European Union will release its bank stress tests for 91 European-based banks.  Traders will pay close attention to the discount applied to various sovereign issuers in an effort to determine what the “worst case scenario” looks like. 

 

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