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Stock Market Summary - February 7th 2008

You could have sold tickets to today’s trading action on Wall Street as it was like watching a professional wrestling match. Bulls and Bears were going at each other today with all they had.  We opened lower with the additional bad news this morning on the economy (Housing, retail, and unemployment) and it was looking like it was going to be another blood letting in the market. But the bad economic news sent expectations of another rate cut from the FOMC upwards again and the market started pricing in another cut. And additionally there was talk from the European Central Bank’s (ECB) director that opened the door to a possible rate cut in the future. This too added some fuel to a brief rally in the markets because if the ECB cuts their rates it will help the value of the US dollar as the Euro will decline on their rate cuts. 

But then later in the day as Fed member Fisher was speaking about the economy he stated that the FOMC must be careful not to "juice up" inflation. Well the inflation word took some air out of the bulls and the market started selling off again because when the Feds talk about inflation then the probability of another rate cut drops somewhat. And this market is addicted to rate cuts just like a drug addict.  Our economy is run on credit, and credit is what is at risk now. And the FOMC has to balance economic growth, credit seizure, inflation, and the risk of devaluing the US dollar even further. The FOMC has essentially become a medical triage team, just keep the patient comfortable and alive. But the real ailments of the economy are never addressed. The first step an economic doctor would need to do is cure the United States deficit, which with the 2009 budget proposal will sent the deficit to new record levels.

Now, back to this morning’s economic data. The weekly unemployment claims data came in at 356,000 and the continuing claims was still rising. And although the initial claims were less than last weeks data the trend of the deteriorating employment continues to point upward. I would expect to see initial claims rise as high as 450,000 by March and unemployment to inch up to 5.4%. What happens after that depends on the credit situation which is almost at a point of seizing up.

Retail sales data, as reported in today’s ICSC chain store data rose 0.5% in January. This is the weakest result on record going back to 1970. The declines were fairly wide spread with the only exceptions being wholesale clubs and drug stores. When the retails sales came in poor for the holiday shopping season some talking heads said that conditions would improve once all the gift cards were redeemed. We wrote back at the end of December that gift cards were not going to matter, the fact was (and still is) the consumers are spending less. Wal-Mart even said that they saw lower gift card redemptions and a high percentage of those that are being redeemed are being used for essentials such as food. If people have to use gift cards to buy their groceries instead of buying something they want for themselves then that says something about how stretched the average American is. Weakness in consumer spending is going to be a problem for a long time.

Also today we got the consumer credit data. It is the amount of revolving and non revolving credit that is being carried by people. In recent months the amount of debt being carried on credit cards was rising at a much higher rate than normal. In a post I made on December 7th, 2007 I discussed the credit card debt situation. By examining the data in a spreadsheet an interesting thing was visible. What appears in the data is that the amount of credit debt increases at a faster rate when the economy is contracting. More and more people are using credit cards for cash and to pay their bills. So the rate increases faster as the cost of living (inflation) continues to pinch the consumers more and more. Then when recession hits we see that the rise in credit starts to tail off. I attribute that to the acknowledgement by the average American consumer that "times are tough" and they start to go into shut down mode. They cut back on discretionary spending even further and go into survival mode. Then as the economy begins to improve we see the trend of credit debt begin to rise upwards again. Over the past 6 months or so we saw the rate of debt increase rapidly, just like it did before the recession of 2000 / 2001. Now today we get data that shows the rate of rise has slowed down somewhat. I see this as the sign of people starting to go into "survival mode" and cutting back even further now. This is a domino effect on the economy, consumers curtail discretionary spending more and more leads to lower retails sales, more lay offs and higher unemployment, and that leads to even deeper cut backs on spending. It becomes a chain reaction.

An additional problem, which we did not have in the last recession is that this time we are seeing banks raising their lending standards, cutting off more people from the credit they need to survive and continue spending. The losses by many banks and financial institutions with the credit crisis has forced them to tighten their lending standards. So this is likely to add to the problems of the consumers ability to obtain money. And they can’t use their homes for equity because of the deteriorating home prices. Credit is dangerously close to a full seizure in this country.

And the last bit of data today was pending home sales. The decline in home sales was another 1.5% decrease for December. Pending home sales has now decreased 24.2% in one year. The rate of decline shows no let up yet in the housing market.

Where does all of this leave the markets? For now it continues to be a sell on strength environment. I still expect to see the markets re-test the lows from the middle of January. We remain in capital preservation mode. We want to get in the market and trade, but we won’t trade foolishly. We will wait for the best risk to reward profile to present itself before we make our entries. Today’s wild swings is a perfect example of why we are hesitant about being in the market. The swings would put our money management rules into action and we would be forced to close out the trade. So it is better to wait for a better opportunity to present itself.