Kansas Fed President Hoenig is no stranger to dissent but he blasted "Bernanke and his allies" on Friday for keeping rates low for an extended period.
Hoenig has been a dissenter at the FOMC meetings but now he has taken his arguments to the people at a Nebraska town hall meeting. In these comments Hoenig joined a growing group of Fed heads including Bullard, Plosser, Fisher and Lacker in speaking out against the current Fed policy. The highly visible and highly critical comments about "Bernanke and his allies" reminds me of the buildup to a WWE tag team grudge match where the two sides spend a couple weeks spouting testosterone fueled remarks and criticisms at the other before they actually show up in the ring.
Some of Hoenig's remarks included:
I wish money was really free and that there was a painless way to move from severe recession and high leverage to robust and sustainable economic growth, but there is no shortcut.
A zero rate after a year of recovery adds to uncertainty.
Zero rates during a period of modest growth are a dangerous gamble.
Slow growth is not a decline in growth and we should not act hastily.
The Fed is inadvertently adding to uncertainty.
A continued zero interest rate is as likely to be a negative as a positive.
Bernanke and allies are trying to use monetary policy as a "cure all" for "every problem faced by the U.S. today."
Keeping rates too low for too long will lead to another severe recession in a few years.
Hoenig is obviously tired of just being a dissenter at the FOMC meeting and has decided to take his feelings public. You can imagine the climate in the room the next time the Fed meets on September 21st. Hoenig believes the economy is on track and growing modestly while at least half the Fed is more concerned about the potential for deflation. I would love to be a fly on the wall in that next meeting.
The Hoenig comments were about the only excitement on Friday and most of that was generated by the talking heads on stock TV simply to have something to talk about.
The economic reports were actually positive but they did not get much press. The Consumer Price Index headline number rose +0.3% after three consecutive monthly declines. The spike was mostly due to a jump in energy prices so the good news was muted. Energy prices at the consumer level rose +2.6%. The core CPI rose only +0.1% and barely over a deflationary reading.
The CPI showed that inflation was nonexistent and deflation is a moderate fear. As long as even modest GDP growth continues then deflation will not be a problem but we are teetering on the brink. Goldman Sachs upped their estimates for a double dip to a 25-30% chance on Friday.
Retail Sales for July rose by +0.4% and slightly better than consensus estimates of 0.3%. Again, a rise in energy prices pushed sales higher at service stations to inflate the headline number. Out of the eleven top sectors auto sales and parts rose +1.6%, service stations +2.3% and eight sectors had sales declines. The remaining two sectors, food services and nonstore retailers were up only +0.2%. If you remove autos and gasoline the headline number would have been a decline of -0.1%. There was no reason to cheer about retail sales in July.
Next week we will get earnings from about ten major retailers including HD, LOW, TGT, ANF and others. Last week we saw JCP, KSS, DDS and JWN lower guidance so the results from the big stores next week are not expected to impress traders.
The first reading of the Consumer Sentiment for August showed an unexpected +1.8 point rise to 69.6 after the nearly -10 point decline last month. The early month gains in the stock market to 10,700 on the Dow were probably responsible for the minor increase in sentiment.
Unemployment, the limited access to credit and weak home prices remain the biggest drag on sentiment. Add in the constant economic gloom and doom in the news the last couple weeks and I am surprised the number did not drop another 10 points.
Consumer Sentiment Chart
Economic reports for next week will give us a couple housing reports and the Philly Fed Manufacturing survey. The housing reports will be bad so no big surprise there unless there is a change to the upside. The most watched report of the week could be the jobless claims since last week's 484,000 was the highest since February and the second consecutive week over 480,000. That suggests companies are not staffing up for the holiday manufacturing and shipping season, which occurs over the next two months. It actually looks like they are cutting back from prior plans.
It was Friday the 13th but workers at one company found some good luck when the alarm clock went off. IBM announced it was buying marketing software company Unica (UNCA) for $400 million. It is not a big deal for IBM but it was a big deal for investors and any employee holding Unica stock. Unica shares rallied +118% to $21 on the news. Yes, it more than doubled on the announcement.
Blackstone Group announced it was going to buy Dynegy (DYN) for $4.7 billion. The three-way deal will also have Dynegy sell four power plants to NRG Energy. Dynegy has been under pressure of late and sold eight plants in 2009 for $1.5 billion in cash and stock. They have lowered guidance several times over the last year. The CEO of Dynegy said the deal would give shareholders a satisfactory exit ahead of rising commodity pressures, challenging capital markets and environmental and regulatory uncertainties. Shares of DYN rose +63% on the news. Given the ugly chart I suspect any remaining shareholders were glad to get the news. There was a 1:5 reverse split back in May that did not even slow the decline.
Cisco (CSCO) did not bounce on Friday and closed the week at $21.37 after disappointing investors with cautious guidance on Wednesday night. CEO John Chambers told analysts "We are seeing a large number of mixed signals in both the market and from our customers' expectations, and we think the words "unusual uncertainty" are an accurate description of what is occurring." Normally John Chamber is a cheerleader for Cisco and the market and this was not the case on Wednesday.
The CFO said in an interview on Thursday "Our customers are just taking a slight pause. But a pause does not mean a stop. It just means they are pausing, they are holding back." However, the CFO said the slowdown came in June and early July and orders improved towards the end of July.
Various analysts echoed the thought that corporations are very gun shy and they are poised to spend money if the economy improves but they are also poised to slash spending quickly if the U.S. falls back into recession. Nobody wants to get caught very over extended like they did in 2008. That was a management lesson for many new managers and for some it was probably terminal. For those that escaped with their jobs intact they are not going out on that limb again until the recovery is on solid footing.
Cisco's sales are a leading edge of the IT build out cycle. The networks have to be in place before any servers or PCs will function. If Cisco is seeing a pause in orders then everyone else is seeing the same thing. We are likely to see this when Hewlett Packard reports earnings next Thursday. Personally I believe Cisco is a buy at $21 for longer-term holders. They have no real competition although there are several competitors. They are the 800-lb gorilla in the space.
On Friday research firm Gartner cut their IT sales projections for the rest of 2010. Overall they expect IT spending to hit $2.4 trillion in 2010, up from $2.3T in 2009. However, they cut their estimates from a +4.1% growth rate to a 2.9% growth rate. It was just a few weeks back they were expecting a 6% growth rate. Gartner said companies were still cautious about committing to new projects and were still worried about the potential for a double dip recession. Decision-making cycles were still long and many companies had contingency plans for the next 12 months, which could see more projects suspended if the economy continues to weaken. This is just another confirming data point that the economy is not well. The patient may be off life support but still not out of the hospital.
In another Gartner survey the company found that the Android smartphone had moved into third place worldwide and pushed Apple's iPhone into fourth place. Gartner rated the smartphones by operating system to cover all the phones in a certain class and Symbian was first with 25 million units in Q2 followed by Research in Motion at 11.2 million and Android at 10.6 million. Apple came in at 8.7 million. Following in distant fifth was the Windows Mobile at 3.1 million. A total of 61.6 million smartphones were sold in Q2. Android was the top selling phone in the North American market but RIMM squeaked ahead overall because of its sales overseas.
When actual units were counted by brand the number of phones of all types sold jumped to 325.5 million. That is a phenomenal number to me and this is in a weak global economy.
Gartner Mobile Device Statistics
J.C. Penney (JCP) warned on Friday that earnings this quarter would be below street estimates. JCP expects to earn between 16 to 20 cents and the street was expecting 24 cents. Penney also lowered the full year estimates.
Joining JCP in sharing weaker guidance and/or flat sales was Kohl's (KSS), Nordstrom (JWN) and Dillards (DDS). Penney reported a sharp drop in same store sales in July and was forced to slash prices to generate traffic. Kohl's beat the street estimates on earnings but guided to lower full year profits than analysts were expecting. Kohl's said the biggest problem for their middle class customers was unemployment. Even those who had jobs were spending less because they were afraid they could lose their jobs if the economy slowed again.
It is pretty clear by any metric you care to use that the U.S. economy is on shaky ground. There are dozens of indicators and plenty of anecdotal evidence that consumers and corporations are worried about what the future will bring. The election battle is heating up and there is a stark difference between the opinions and actions of the candidates. The general election tactic is to paint a picture of how bad it is and then claim the ability to fix it. What consumers remember is the picture of how bad it is now. They seldom remember the proposed fixes because the description of the fix is normally disguised in political speak so that candidates can't be pinned down on the specifics. The bottom line is that the next two months is going to be filled with a lot of political whining and finger pointing and a further decline in consumer sentiment.
The uncertainty has confused investors. Add in the flash crash, the politics and new regulations plus the major increase in taxes several months from now and cautious investors are now petrified. They would rather put their money in bonds or TIPS and get a half percent than risk it in the stock market. The yield on the ten-year TIPS is roughly 1% and the five-year just barely over zero.
TIPS Yield Chart
Why are investors so scared of the equity market? First this is historically the worst two months of the year. Secondly every single news item these days is a discussion of the potential for a double dip or even worse the onset of deflation and a lost decade like Japan suffered through. The Fed can't create inflation today despite their efforts. Fed rates are at historic lows and the Fed tells us every month that they will remain there for an "extended period" because of an "unusual uncertainty" in the economy. That is not particularly confidence building.
Corporations are sitting on a monster pile of cash but they refuse to spend it because of the painful memories of 2008. Banks are sitting on a pile of cash and they are hoarding every penny because of the real estate problem. A large majority of their loans are underwater loan to value but regulators are looking the other way to avoid another banking crisis. They know that once the economy starts accelerating the real estate problem will solve itself. Until then the banks have to hoard reserves just in case that recovery doesn't come anytime soon. Eventually regulators will have to recognize the underwater loans and banks will have to add to reserves. The FDIC closed another Illinois bank on Friday. The Palos Bank and Trust Company was the 110th bank closure of the year. There are more tan 700 banks on the FDIC problem list.
When one of these banks is closed the FDIC sells the assets to another bank in the region. This is another reason banks want to hoard reserves. They might get a golden opportunity to acquire some market share and choice assets if another bank in their area fails.
Most people believe the Fed stimulates the economy with its rate cuts. Those do provide a sort of stimulus but the real economic stimulus is bank lending. When a bank raises $1 million and then leverages it into $20 million in loans it creates a huge amount of activity. Those borrowers buy equipment and supplies, pay salaries, rents, etc and business activity skyrockets. We are not seeing that now. Banks are hoarding the money. They claim they are making loans but the numbers don't lie. You have to have perfect credit and a golden balance sheet to get any bank funding. Few small businesses and startups have either after the last three years of crisis.
Knowledgeable investors understand these problems and they have been conditioned over the last 80 years to fear deflation much more than inflation. The Fed went for years and would not even say deflation. Now the word is in every sound bite. Baby boomers who survived the recession crash and escaped with some of their portfolio intact have been selling those stocks and stashing the cash. They have to count on that cash when they retire over the next few years and they don't want to risk it in the market. If a boomer planning to retire on the result of his last 40-years of investments saw his million dollar account turn into a half million account during the crash then he was scared to death that his retirement may have to be postponed. When the rebound came and those accounts reinflated those potential retirees are cashing out and putting cash in the safety of bond funds and TIPS.
Remember in the years leading up to the crash consumers treated their homes like automatic cash machines. Refinancing annually to extract more cash was a common event. That cash fueled the last decade and created the bubble we all enjoyed. That unlimited cash machine no longer exists and consumers are forced to live on what they make instead of what they can borrow. It is a sharp decline in lifestyle and for boomers getting ready to retire they now have that mountain of debt and a loan to value that may require cash to close rather than be a cash generator. The volume of cash extracted from real estate has declined by nearly $1 trillion since 2008. Times have changed and the easy life of buy and flip home ownership is gone. This is called deleveraging and it is happening on a nationwide scale. As long as deleveraging is the primary driver of the economy growth will be minimal. Deleveraging is deflationary.
Cash Extracted from Real Estate
The era of easy credit, liar loans and sub prime buyers is gone. In order to sell merchandise whether it is houses, cars, motorcycles or golf clubs the prices have been slashed and then slashed again. Prices are falling on everything. This is called deflation but we are not quite there yet. We are hovering on the brink but there is still hope of a recovery. The Fed is going to make money so cheap that a new round of inflation appears. Some analysts believe the Fed is going to push the yield on the 10-year treasury to 2.5% in order to create inflation and a new home buying, home refinancing bubble. They want to recreate the real estate cash generation wave. It is the easiest way to put cash in consumer pockets in enough quantity that they will again feel confident and spend the money.
This won't help the boomer generation because most are only 5-7 years from retirement. When people retire they trade down in house size. The money they get from selling their pre-retirement property goes into saving for retirement expenses. There are some analysts that believe the entire next decade, when 42 million boomers will retire, will be a deleveraging decade. That is far too long term a time horizon for this commentary but it does make sense.
Right now the key is to decipher how this affects our markets. In the absence of government stimulus the economy is going to grow slowly. I am not in the double dip camp but I believe the economic growth will be slow. There are simply too many people unemployed to put them all back to work in less than three years. Add in the deleveraging and the conversion of stocks to bonds for risk free retirement cash and we have an up hill battle but it is one we can eventually win.
I was amazed that so many analysts were surprised the market declined last week. You would have thought they were living in a cave and ignorant of the external influences. The simplest of those influences was option expiration. I told everyone last week that the most volatile week is the week before option expiration and to be aware. The economic reports and poor earnings guidance helped grease the slide. Now that we are into the slide and the uptrend has been broken the path of least resistance is down.
I have heard analysts use nearly every bearish pattern or technical indicator they could come up with as the reason the market broke and why it will continue. Guys, it was time for the market to rest. The excuse did not matter and there were plenty of excuses.
Now we have to decide where to make a stand and go long because daylight always follows darkness. Problem is we don't have a reliable market clock so we don't know how much darkness is left. The clear target on the S&P is 1050 followed by 1014. Neither level represents the end of the world. It is just normal Q3 market movement made more volatile by the frequent use of the word deflation in the news and those conditions I described above. I believe we will see 1050 and I would like to see 1014.
The remaining weak holders need to be removed from the market but more importantly fund managers need to be given a defining "reason to buy" as we head into the fourth quarter. A continued decline to 1050 could produce another trading range swing while a serious drop to 1014 could be a defining moment for the rest of 2010. I would love to see that happen. We don't want to see 1014 broken but definitely tested.
Initial resistance on the S&P is 1087 and the 50-day average followed by 1100, 1115 (200-day) and 1130.
The Dow broke under prior resistance at 10350 at the open on Thursday and remained stuck there through Friday's close. The good news is that support at 10300 was also firm. The reason the Dow failed to move appreciably on Thr/Fri was a lack of volume. Volume on Friday was the second lightest day of the year at 5.9 billion shares. The lowest day of the year was Monday's rally. Those days were bookends to Wednesday's 8.5 billion-share day. That was 33% more volume on Wednesday but only 500M shares were up volume. It could have been a capitulation reversal day but the bulls failed to show. The big cap techs in the Dow along with the materials stocks and energy stocks were too weak for any rebound to materialize.
There was a discussion of the TRIN in the Market Monitor on Wednesday. The TRIN hit 6.31 on Wednesday and according to Art Cashin there have only been six higher readings in the last 28 years and one of them was the 1987 crash. In theory a reading that high is followed by a rebound. In theory a 16:1 volume imbalance day like Wednesday is also followed by a rebound. Obviously theory and reality were not in agreement on Thursday.
I am surprised there was no real attempt at short covering at Friday's close. After a -350 point decline you would have expected some short covering before the weekend. That gives you an idea what traders are thinking when they have no fear about holding over over a weekend.
A break of support at 10300 targets 10100. I really don't have a target after that. If the decline continues it would not be unreasonable to see 9800 again. The last few months on the Dow have been so choppy there is no clear support at least for me. Dow 9614 was the July 2nd low. That seems like months ago to me instead of just six weeks.
The Nasdaq is under serious pressure. Big cap techs are broken as evidenced by the collapse in Cisco and Intel. The chip sector has broken down to a new six month low and there were more than a dozen downgrades last week. For an investor to buy any PC related stock today would require a serious leap of faith.
The uptrend has broken and the Nasdaq lost more than 5% for the week. Initial support is 2140 followed by 2063.
The Russell gave up -6.3% for the week compared to only -3.3% for the Dow. The dramatic decline for the Russell is a clear indication fund managers are bailing on the market. In times of stress they do not want to be in small caps. The Russell closed at the low for the week and appears to be targeting 590 for support. A break under 590 would be VERY bearish. It is amazing to think that just three days ago the Russell was comfortably over support at 640 and the 200-day average. Market sentiment has deteriorated rapidly and the Russell is our leading indicator of fund manager sentiment.
In summary the uptrend from July 2nd has broken. The chips stocks are at six-month lows and the big cap techs are broken. There is very little anyone could say positive about this market. Earnings were better than expected but came from cost cutting rather than sales and guidance was less than stellar.
The economy is not broken but is weaving its way forward like a drunken sailor. There are faint signs of improvement in the last two weeks of July and early August but the recent reports from companies like Cisco and probably Hewlett Packard next week may have killed off those improvement hopes. A two-point improvement in consumer sentiment can easily be erased by weak guidance from Cisco.
I am still in the "why buy" camp until we get a little farther into the quarter and traders start to position themselves for a Q4 rally. Whether we actually get a Q4 rally is problematic but traders will be positioning for one in late September anyway. Keep your powder dry and lets see how this decline shakes out.