U.S. stocks gained ground on another Merger Monday and as Intel’s board authorized a higher dividend payout and a dramatic increase to their latest buyback program.  The Dow made a charge to the 12K mark, and the S&P 500 moved closer to 1300.

The merger of the day came when Smurfit-Stone agreed to be purchased by paper/container packaging company Rock-Tenn.  Rock-Tenn paid close to a 30% premium to Smurfit’s closing price on Friday. 

On the Intel news, I would have liked to see a bigger increase in the dividend (they’ve got the yield up to 3.40%, but a higher payout ratio that gets that yield to 4% is probably what’s needed to get the stock back above $24/share).  The company apparently sees a buyback as more important as they know earnings per share comps are going to be really tough to beat as we move into the second-half of the year. 

Tech, industrials and basic material (ended a three-session slump) shares led the broad market higher.  Financials and health care were the only of the 10 major industry groups to close down for the session. 

Well, we heard that refrain again.  You know, the one I’ve been ripping on for some time now:  “The U.S. dollar gained ground on the improved growth outlook.”  The financial press pulled this comment-card out again as the greenback was rallying a bit yesterday morning.  Well, around lunchtime the outlook must have deteriorated rather abruptly as the dollar quickly reversed course to go negative for the session.   More on this beyond the click.

Market Activity for January 24, 2011

Seriously though, the near term outlook didn’t suddenly change midday; the belief that the outlook for U.S. economic activity is driving the dollar is simply without merit as the greenback is down 6% since August – the month in which the growth outlook improved.  No, the dollar’s direction is completely a function of what the euro is doing these days, which erased losses midday.  The dollar will continue to be driven by the euro until the next scare comes along and everyone moves back to the greenback    Once the economy proves activity is self-sustaining and doesn’t need the latest iteration of fiscal stimulus or an unprecedentedly easy monetary policy (which cannot be proven until policymakers stop stuffing short-term stimulus in our collective face) the dollar’s direction will again be driven by the economic outlook but not before.

And on that turn in the euro, it seemed to come from comments from ECB President JC Trichet when he reiterated the central bank will be vigilante on inflation.  This appears to be more talk than anything as the ECB probably has its hands tied due to the eurozone’s government debt and financial system woes.  The comments are no more believable than if our own Fed were to state they’d voluntarily change course with the unemployment rate close to 10%.  And while we’re talking about the Fed…

Fear and Loathing in the Eccles Building

Man, to be a fly on the wall in the Eccles Building (where the Federal Reserve Board of Governors reside).  Bernanke & Co. must loathe thinking of the unwind to the current policy stance.  Just as the ECB is trapped, how exactly is our central bank going to halt their bond purchases and then raise rates?  There is housing, debt servicing, the interest-rate risk within the balance sheet and of course the mandate to maximize employment that either keeps Bernanke up at night, or should.

Let’s touch briefly on each of these topics that are forefront in the mind of Bernanke. 

*  Housing demand is weak (sure we’ll see monthly pops on occasion but on average home sales are way too weak to absorb the coming supply).  Bernanke is surely thinking about this market, and what an increase in rates will do to further soften sales, which risks another big leg down in prices and more trouble not just for households but for the banks.

*  Federal government debt servicing is running about 12% of revenues and 8% of spending.  That’s just on marketable debt, add in unfunded liabilities for Medicare and Social Security and you get to 18% and 12% -- even at these silly-low interest rates.  Even a mild tightening, say to 2.0% fed funds, drives debt-servicing to roughly 25% of revenue and 20% of spending.  If interest rates were to fully normalize then we’re talking the funds needed just to service the debt overtakes those needed to fund Social Security.

*  The Fed is buying all of those longer-end Treasuries, which should approach $500 billion by June 30 using a conservative assumption.  As interest rates rise, those positions will get crushed.  As former Federal Reserve Bank of Atlanta President Bill Ford recently stated, the Fed will move from sending profits to the Treasury to needing cash injections from the Treasury as the losses mount.

*  Then we have the Federal Reserve’s mandate to maximize employment.  At 9.4% (and going to test 10% again before the jobless rate goes lower) employment is hardly maximized.  The so-called “natural rate” of unemployment is roughly 5.5%, which is what policymakers define as maximized employment.

So how exactly is the FOMC going to reverse course in a timely manner if price pressure continue to build?  The likely answer is they won’t. 

Undoubtedly, the Fed has backed itself into a corner, and their job hasn’t been made any easier by a spendthrift federal government.   Ultra-easy monetary policy and massive public-sector spending may have caused things to look better in the very short-term (although one can argue that the government spending has hurt job growth), but increases the challenges ahead.  We’ve talked about these topics for quite a while now and they’re among the main reasons I’m not constructive on this move in stocks.     

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Have a great day!

Brent Vondera, Senior Analyst

Phone: 636-449-4900