U.S. stocks enjoyed the most robust rally since prices began to sink six weeks ago as the market viewed some actions in China in a positive light.  Basic materials, energy and industrials led the rally.  Utilities, financials and telecoms were the laggards, but even these groups closed higher.

Unfortunately, as go stocks so goes crude and gasoline prices – and at these levels this is the problem of that high positive correlation.  Crude approached the $100 mark, settling at $99/bbl, and wholesale gasoline was up six cents to $3.06/gal. (so $3.70 retail isn’t going anywhere until that wholesale price falls below $3).

On that China news, the PBOC (central bank) yet again raised their reserve requirement ratio for the banking system to a record 21.5% in order to contain lending after the latest inflation data printed 5.5% y/o/y – the food component up 20% y/o/y.  U.S. stocks were hot in pre-market trading on that news, which is quite the sentiment change as the previous increases in the ratio resulted in stock-market weakness on growth concerns.  Now, at least for one day, the market likes the move in the hope that the Chinese will get a grip on inflation and foster a soft landing (although there are reports that the shadow banking system remains out of control, so not sure how soft the landing’s going to be).

The Dollar Index lost a little ground and the CRB Index advanced as not only the prices of energy rose but 12 of its 19 components advanced.

The annual conference for fiscal responsibility (which is a laugh in and of itself for any year, but especially so now) was held yesterday and Mr. Bernanke was among the panelists.  He scolded Congress not to use the debt ceiling as a tool for fiscal policy (telling Republicans not to demand substantial spending reductions before approving yet another increase in the higher debt limit) because it will adversely affect the dollar.  What!?   The guy who runs the system that has the greatest direct affect on the currency – and whose policy decisions have been the driving force in diminishing the value of that currency -- actually has the nerve to lecture others on the issue.  That is height of hypocrisy.

Market Activity for June 14, 2011

Sector Activity for June 14, 2011

NFIB

One can sum up the National Federation of Independent Business’s gauge of small business confidence in one word:  ugly.  For May, the gauge fell for a third-straight month to remain at past-recession levels – save a two-month jump to a reading of 94 in Jan. and Feb. this gauge has remained at recessionary levels for three years.   As the chart below illustrates, this measure rarely dips below a reading of 95, a level we’ve been below since November 2007.

The gauge slipped to a reading of 90.9 from 91.2 for April as the plans to hire, capital spending and plans to increase inventories fell from already low levels.  And while expectations for a better economy, higher sales and a good time to expand measures improved from the month before, they remain at very depressed levels.

PPI

The producer price index (PPI) rose a larger-than-expected 0.2% (expected at +0.1%) that was largely a result of another 2.7% jump in the gasoline component – the June data will post a nice decline.   This drove the y/o/y increase to 7.3% -- the highest level since 2008 when it hit 9.1% as crude rallied to $145/bbl.

People are beginning to talk about stagflation, and you can understand why as these inflation gauges continue to rise even as growth decelerates from an already pathetic rate.  But the inflation gauges are lagging indicators, and they will begin to post decelerating rates of price increases a couple of months out as gasoline has come down and economic activity has decelerated – so the stagflation scenario is likely to come but it won’t occur in a continuum.  Growth is just too weak and consumers, in general, have neither the willingness nor the ability to expand credit.

The inflation gauges will not begin to jump again until the Fed implements it’s next round of QE – it’s coming, just watch.  This will do nothing to spur the economy, only increase asset prices to levels that make the subsequent decline deeper. Why must stock prices decline?   Because this is a mistaken policy path, one that holds back job growth and livings standards as it drives commodity prices higher and will shock an economy that it’s now conditioned to ultra-low rates when the time comes to unwind this policy error.

Retail Sales

The Commerce Department reported that headline retail sales fell in May for the first time in a year from a downwardly revised April increase.  Exclude gasoline and sales fell 0.3% (gasoline continued to consume more of the pocketbook – see chart).  Exclude gas and autos (auto sales were down big) and sales rose 0.2%.  Core sales – ex gas, autos and building materials – also rose 0.2%. All of these figures have printed some serious deterioration of late. And adjust for inflation, which is what matters for GDP, and all of these figures are down for two-straight months.

As stated, auto sales were down big as they fell 2.9% in May – blame it on Japanese supply-chain issues all you want but since we see declines in other areas I think it’s more than just Japan.  Furniture sales fell for a second-straight month, electronics sales down two months in a row, sporting goods held to that trend too.   But eating & drinking was up 0.6% after the 0.8% decline in April and internet sales jumped 1.2% after the 1.3% rally in April.

The way consumer activity is shaping up, now that the stock market has foundered and those tax refunds have been spent (specifically from the $8K home-buyers tax credit, it’s highly likely that the payroll tax rate reduction will be extended into 2012 (the social security portion of the FICA tax was cut by two percentage points and was supposed to expire at the end of the year).  Now the administration is talking about cutting the employer side of that tax.  It will do nothing but dig a deeper debt hole, but short-term Keynesian policy is all current policymakers know – they simply refuse to implement tax policy that incentives business and entrepreneurial sprits and lead to a larger tax base.

Business Inventories

Business inventories rose 0.8% during April, according to the Commerce Department after an upwardly revised 1.3% increase for March.  That March revision, previously reported at 1.0% will provide a boost to Q1 GDP so that it may surpass the 2.0% level -- it was previously estimated at 1.8%.  But since the boost is coming from inventories, that means the real final sales measure (GDP’s gauge of final demand) will fall to an even weaker level.

Anyway, the April increase in inventories was totally boosted by a 1.3% increase among manufacturing stockpiles as retailers have been unwilling to allow stockpiles to build much for several months.  Business sales data barely budged in April, up a scant 0.1%.

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Have a great day!

Brent Vondera, Senior Analyst

Phone: 636-449-4900