A Disconnect From Reality…

There seems to be a major disconnect in the markets these days.  A disconnect from reality, really.  There’s a chasm between consumer confidence and business leaders.  We are hearing so many company CEO’s remaining confident in US and foreign spending. Even when they do acknowledge a "softening" in the US, they fail to recognize weakness in foreign economies.  Consumer confidence numbers here and abroad are coming in very, very low.  Maybe business should listen to the consumer.  They aren’t "talking themselves into a recession", as we’ve heard some say.  They simply know how much income and savings they have at their disposal, and it’s not enough.  They know how much more they are having to pay for food, gasoline, utilities, housing and transportation (autos).

We’re living through a manic phase of the market.  For instance, if some say oil prices will fall on US dollar strength, then any small rise in the dollar is met with the selling down of oil company stocks.  This might last a day or two, then manic buying ensues once again, as the price of oil just continues to rise.

It’s the same wrong thinking in regard to the Federal Reserve actions. "Oh, the Fed cut interest rates, so everything in the market will be fine!"  Oops!  Not so fast!  Interest rate cuts haven’t stimulated the economy or lowered borrowing costs.  It hasn’t restored confidence in our financial systems.  Those cuts were unable to halt the housing price decline and foreclosure rates increasing.  They couldn’t make up for years of no rise in real income either.

The talk of late is that the US Dollar is starting to rebound. Some media commentators have gone as far as to say this signals a stop to rising oil and gold prices. In 2004 to 2006 the Federal Reserve raised the Fed Funds rate a total of 17 times. During that time the US dollar stopped it’s decline and headed up throughout that time period. Soon after the Feds stopped raising rates, and left the economy to its own devices, the dollar started falling once again. And not only did it fall again but it went even lower than its previous lows. This clearly tells us that, left to its own devices, the economy can’t sustain itself and begins to fall apart once again. The only way the US Dollar can be elevated in price is by artificial stimulation by the Federal reserve, not from organic growth within.

The economy is much worse now than it has been in a very, very long time. Any upward movement in the dollar will be quickly lost once the economy is left to function on its own. And, an economy that needs to be constantly stimulated artificially is akin to someone being on life support.

This mornings GDP revision up to 0.9% is so out of touch with real economic factors that you can mark this date and come back to this and see if I am correct in what I am about to say. This summer, when the Government can issue a final revision to this quarters GDP I can assure you that it will be revised downward.

And unemployment is still rising, continuing claims is growing every week. Recently we learned that teenagers in this country are finding it difficult to find summer work. The reason is obvious, older workers are having to get a second (or third) job to make ends meet. Or it is unemployed workers taking whatever they can get, even flipping burgers at the local fast food joint. So this leaves the country with the 16 to 19 year olds unable to find work at historic levels.

U.S. JOB MARKET: TEEN SUMMER JOB MARKET WEAKEST IN MORE THAN 50 YEARS - CENTER FOR LABOR MARKET STUDIES AT NORTHEASTERN UNIVERSITY IN BOSTON
- According to The New York Times: "Little more than one-third of the 16- to 19-year-olds in the United States are likely to be employed this summer, the smallest share since the government began tracking teenage work in 1948, according to a research paper published by the Center for Labor Market Studies at Northeastern University in Boston. That is a sharp drop from the 45 percent level of teenage employment reached in 2000."

There is no fundamental reason at all for the equities market to be trading at -11% from the October 2007 high (S&P 500). The fundamentals of the economy as they stand currently should have the forward market trading at levels at least 20% down. And not only that, the economy is still deteriorating further, and at a faster pace. I said in a recent commentary that retail sales for the quarter we are in now will be very bad. Consumer spending has taken a substantial hit and so will the retailers. Sears/Kmart (SHLD) reported this morning numbers that were abysmal. Same store sales down over 11%. Now, I know Sears is nothing great. But, it is one of those kinds of stores that usually has a constant, albeit light, sales revenue year after year. The products they offer attract a certain type of buyer who goes there when they need a new vacuum cleaner, dishwasher, or power drill. A steady flow of revenue. One can say that their sales declines are just a result of bad management (which someone in the media did say), or perhaps it is due to the economy… hmmmm.

There is talk that the Federal Reserve is finding itself in a vice, they need to keep interest rates as low as possible to keep the pipes open as best as possible for money to flow from bank to bank, and to help stimulate the economy, even if it is just a little bit. But, now they are already talking about raising rates "sooner than later" as one Fed speaker said recently. All due to the rising inflation which for so long they kept saying "is anchored". This is partly the reason you are now seeing bond yields taking off to the upside. Rising yields will be like tree roots breaking into the pipes and clogging up the very system the Feds are trying to keep open. The housing market is in shambles, banks have drastically tightened up credit lending, and if you add rising interest rates to this mix you will simply add to the housing market decline and send it further down the rabbit hole.

Large companies are making adjustments to their production lines (General Motors, Ford, etc) to adjust for the rising inflation and manufacturing costs. Dow Chemical announced that they are forced to raise the retail prices of most of their products by 20% due to rising manufacturing costs. If inflation (i.e. oil prices) was simply a short lived bubble as the media is now saying it is, then why is it large corporations are making expensive adjustments to their long term plans? They don’t go and make those kinds of changes if they think oil prices are just a bubble. No, they make those kinds of long range changes based on expectations of the situation lasting for a protracted period of time. The only ones who say that oil prices are a bubble is the talking heads in the media. You don’t hear that coming from the companies that are trying to survive.

And what about the rest of the world? That which has been touted as being the savior of the US stock market.

 

JAPANESE DATA SHOWS INFLATIONARY PRESSURES, SLOWING GROWTH
- Japanese household spending drops by the most in 19 months: (JP APRIL HOUSEHOLD SPENDING YOY: -2.7% V -0.9% expected, -1.6% prior) "Today’s figures are bad news for the Bank of Japan as they confirm that the economy is deteriorating while inflation maintains a rapid pace," said Kyohei Morita at Barclays Capital.

Japan’s manufacturers’ PMI declines to a 6 year low: (JP MAY NOMURA/JMMA MANUFACTURING PMI: 47.7 V 48.6 prior; (New exports orders index lowest since Nov 2001) "The latest PMI data suggests that the punchy growth signaled by official data for Q1 is unlikely to be replicated during Q2," said Paul Smith, an economist at NTC Research. "Risks are seemingly skewed to the downside for production going forward," he added.

SOUTH KOREA’S VICE FIN MIN CHOI SAYING THAT THEY MUST CONSIDER WIDENING THE CURRENT ACCOUNT DEFICIT
- 2008 inflation likely to exceed forecasts
- Says external risks are rising for South Korean economy

(UK) GFK MAY CONSUMER CONFIDENCE -29 VS -25E (ECONOMIC EXPECTATIONS WEAKEST ON RECORD)
- May Consumer Confidence Lowest Since Nov 1990
- Major Purchase Intentions Weakest On Record

SPANISH ECONOMY MINISTER: 2.3% GROWTH FORECAST FOR THIS YEAR MAY NOT BE MET

 

These were just from tonight! A lot of other countries around the world are having their own economic declines. If other large industrialized nations are declining, then who is left to do all of the buying that is supposed to prop up the markets?

Judgement day is coming for the markets, and when it hits it will not be pretty. Bear market rallies are vicious, dirty, and downright cruel. And when they break you had better be prepared, for it will be a dozy of a sell off.

 

Requested Gold (GLD) chart:

 

 

 

 

 

 

 

 

One last thing tonight, and it is important. Today, Fed Vice Chairman Donald Kohn, said in a speech that the Federal Reserve is considering a new lending facility that would accept "foreign" collateral for lending to global banks. It is bad enough that the US taxpayers are footing the bill for bailing out Bear Stearns and other failing institutions in this country. But, now they want to potentially put the US taxpayers in the front of the line to open their wallets to bail out global banks! Where does this insanity stop?

THE FED

Fed might accept foreign collateral: Kohn

Should broker-dealers have regular access to funds, or only in crises?

By Rex Nutting, MarketWatch

Last update: 8:22 p.m. EDT May 29, 2008

WASHINGTON (MarketWatch) — The Federal Reserve is actively considering creation of a lending facility that would accept "very safe" foreign collateral from "sound" global banks in case of a widespread liquidity crisis, Fed Vice Chairman Donald Kohn said Thursday.

A new global discount window is "under active study," Kohn said. "It is possible that over time, major central banks could perhaps agree to accept a common pool of very safe collateral, facilitating the liquidity management of global banks," he said, stipulating that such loans only be made to sound institutions.

Kohn’s suggestion came in prepared remarks wrapping up a special conference in New York on liquidity in money markets that was sponsored by the New York Fed and the Columbia Business School. Read his prepared remarks

"Market functioning remains far from normal," Kohn said, pointing in particular to large spreads between overnight bank rates such as Libor and other short-term rates. Such large spreads indicate that markets still are in shock.

Kohn argued that the Fed and other central banks had prevented a global run on Bear Stearns and possibly other major financial institutions in March, but the emphasis of his talk was on what lessons central banks and the financial system should take from the liquidity crisis that spread like topsy from subprime mortgages to asset-backed securities to the collapse of one of the world’s biggest investment banks. See latest story on Bear Stearns

"One of the things we have learned over recent months is that broker-dealers, like banks, are subject to destructive runs when markets aren’t functioning well," Kohn said.

The biggest question is: What to do about the broker-dealers and investment banks that, since the run on Bear Stearns, have now been given unprecedented access to the Fed’s lending facilities? Should that access be continued on a permanent basis? Or should it be provided only in emergencies?

Kohn had no simple answer to that question: "Unquestionably, regulation needs to respond to what we have learned," he said. "Whether broader regulatory changes for broker-dealers are necessary is a difficult question that deserves further study."

Permanent access to the Fed’s balance sheet at attractive rates would distort markets without well-designed and well-executed supervision. On the other hand, everyone in the markets knows that the Fed will step in with funds in an emergency, so in some sense the markets have been irredeemably distorted already.

Kohn suggested that the term auction facility, which was created in December and expanded in early May, should be retained on a permanent basis after the crisis is over. The TAF allows banks to bid to borrow funds from the Fed’s discount window for 28 days.

"The Fed’s auction facilities have been an important innovation that we should not lose," he said. "They have been successful at reducing the stigma that can impede borrowing at the discount window in a crisis environment and might be very useful in dealing with future episodes of illiquidity in money markets."

Rex Nutting is Washington bureau chief of MarketWatch.