Wednesday, June 25, 2008

Market Recap 06/25

---------- Foreword ----------
Busy day, a lot of news, long post. Especially Oil and a special section about Inflation / Delfation. No apologies though, I cover the macros. You can't game 'em and everything else is dependent upon them.

---------- Important Crap ----------

Interest Rates - The fed funds rate is at 2.00% and the discount rate is 2.25%. Fed says that downside risks to growth had diminished since its last meeting, but the upside risks to inflation have increased. Comments: I think the fed is high, but they might not get the next slap in the face till spring 2009. So...if nothing terrible happens...look for a rate hike..the correct choice regardless of the growth scenario.

Dollar - Opened slightly lower, but above 73. Still trading in range before the fed. Post Fed: The dollar didn't take off (and looks to be rolling over) despite the harsh language. The lesson I'm learning is talk didn't do anything. I still think - as more bad news trickles out - we'll fall through 73.

Oil - The Energy Dept stated Oil inventories up were up 800,000 brls. The first increase in 6 weeks.
Comments: This news sent the USO off a cliff and the markets flying. (I'm still waiting for the fed at this time, but doubt a change, and doubt the impact of words.) All in all this is pretty funny. Marketwatch is reporting in big bold letters "Supplies Surprise Hit Crude." Was it really a surprise? Remember on the 06/18 Recap, we talked about how "Oil inventories are down again, but only by 1.2M brls. There is an emerging trend of smaller inventory drops." Where you at MarketWatch? Well, smaller still, so that there is now an increase in inventories. (Awesome graph at Bespoke) Keep in mind the increase is only 4% of a day's supply and supplies have dropped 25M brls in the last few weeks. I am a peak oil believer, but believe this may be a supply / demand "cusp." Watch for either an oil drawdown next week to signal continued demand or a second larger inventory increase to signal continued weakening U.S. demand. In disclosure I'm long oil now. I said I was staying out till after the Saudis and the inventory announcement. I picked up some USO $109 calls after the dash for the door this morning.

Durable Goods Orders - Excluding the 2.6% rise in transportation orders, orders for durable goods fell 0.9%, matching expectations in the market. Excluding the 10.9% rise in defense orders, total orders fell 0.6%.

Department of Commerce said May new home sales fell 2.5% month-over-month on a seasonally adjusted annualized basis, which follows the upwardly revised 4.8% gain in April. Comments
: Falling prices and falling sales. I bet you didn't learn that in Econ 101. Hmmm? What do you mean there's no model for the market behavior or the largest personal asset class in America? LOLs

Monsanto profit up 42% to $811 million, or $1.45 a share, from $570 million, or $1.03 a share - Comments: Then the shares took a 5% swan dive. I'm not sure if the market is done punishing MON, but I think this is a hell of a deal.

Interest Rate Hike Chicken - Was today won by Poland, who's central bank hiked key rate by 25 bp to 6.0%. For those of you keeping score at home, that's Mexico, India and Poland all hiking in the last three business days.

Approval Is Near for Bill to Help U.S. Homeowners...... - Comments: I hoped this was a non-starter. "would allow qualified owners to refinance into more affordable, 30-year fixed-rate loans with a federal guarantee." Great, lock them into overpriced homes while Joes with cash get better deals next door. Maybe their neighbor will quit paying his mortgage too so he can get a great fixed rate government loan. Maybe they'll figure out they've been duped, they'll foreclose on their home and we - the tax payer - will pay off the "guaranteed" loan. Then, Wall St. still gets paid for their screw up, and the homeowner can go shopping for something new...maybe even his old house. However, he can't get a buyer's credit because he's not first time...bummer...even if he could, he can only use it on an unoccupied home. Great Idea! Now lets see how it works in action!

Warren Buffet Warns of Stagflation

EIA: World energy consumption may rise by 57% by 2030. - Comments: Golly, really? Don't tell the oil bears!

EIA: World oil prices may hit $186 a barrel in 2030. - Comments: Well, now that I know it's only gonna go up 50$ a barrel in 2 years.....I'm gonna buy that hummer after all. (Note: This is why you do NOT use economic models for 20 years out.

Countrywide / BOA - Attorneys general from two states filed separate lawsuits against Countrywide Financial Corp. and its chief executive on Wednesday, the same day the mortgage lender's shareholders approved the proposed takeover by Bank of America Corp.

AmEx: Lates rising faster than expected

---------- Random Crap ----------

Yesterday I mentioned I though the U.S. was now in a deflationary period. The comments touched off a discussion and some confusion. So, I'm going to try to summarize what I've seen and keep tackling this Inflation / Deflation issue. My deflation opinion has largely been formed by Mish (Inflation / Deflation).

I think in true Mish fashion we should understand the difference between inflation and price inflation. The difference between credit and money and decide if credit is included in our inflation count. I do count credit and will begin trying to use each of these terms appropriately. If credit is increasing people have more to spend and push prices up accordingly.

DemonDoug has said that when bank issue loan the money is "created out of thin air" and I agree that credit is created out of thin air. He goes on to say "When the borrower pays back the loan, that money that the loan created is now destroyed. When a loan is sent out, but then is not repaid, then that money that has been defaulted upon, but the money stays out there in the netherworld of the financial systems of this world."

Sorry D, I don't subscribe to that last part exactly. When the credit is FIRST created to issue the loan, THAT is the inflationary point, regardless of whether the loan is defaulted on. If the principal of the loan is paid down or paid off, that is the deflationary point. So in 2005 when banks created credit, flipped the loan and repeated the process, THAT was the inflation. The current defaults, by definition, cannot be inflationary, because the credit has already been created. It's not created again during a default. If anything I would say the created credit acts as a supporting base if anything.

Second, I believe everyone has to play along with the game for occasional "inflationary" defaults to work. Defaults should be low, risk/reward should be appropriate and assests should be fairly priced. Again, look at homes...that is the beginning of one movement (dropping prices) and the end of another (cheap money). Once everyone realizes the jig is up, they bail. The credit wealth is destroyed.

When a $100 loan is first going into default, yes the bank has $100 of illiquid assets created from thin air on it's books. Then at default that "$100" asset is sold off for...let's say $50 (but you know more like $10). So now the bank gets the $50 which goes on their balance sheet accordingly. That too is deflationary. The bank has revalued the asset and the new owner has revalued the new asset. Wealth was destroyed because the market has simply devalued your asset (the loan). Some other sucker now has some asset for which he paid $10, but I'm not going to say he's got $100 on his books, or in this economy. Period.

I realize your opinion may be that the "money" - created by overvaluing these homes and issuing mortgages - is still in the system. So I ask you...where is it? Whose is it? When will they get it? How will they get it?

Simple answer...because no one will pay those prices for's gone. Don't believe me? I don't blame you. I featured this on 06/05.

"WASHINGTON (MarketWatch) -- U.S. households lost $1.7 trillion in wealth during the first quarter, as the collapse in the housing market and a weak stock market took their toll, the Federal Reserve reported Thursday.

Net worth had grown by more than $20 trillion from 2002 through the end of 2007, as home values and the stock market boomed.

The net worth of U.S. households and nonprofits dropped at an annual rate of 11.3% in the quarter to $55.97 trillion. It was the biggest drop in wealth since late 2002."

Sorry, that just doesn't sound inflationary to me any longer. It's the difference between credit and money and credit is getting destroyed. I'll have to compare iTulip's perspective to Mish.

As for the commodity bubble, I believe it is a global market and the U.S. will have trouble fueling it. Unlike the housing bubble, a commodity bubble slows the economy. I just think demand is pushing commodities up...some too quickly.

abitarecatania, I see your mish post, and raise you a mish post - Now Presenting Deflation.

AnomaLee, "since the inception of the Federal Reserve." - Perhaps you missed where I said that I believed we entered deflation recently. When home values started dropping, everyone started reeling the money in. True, there is the fed and they're a pain in my side, but they're just loaning - indefinitely - for now. Say what you will about the treasury also...they're not writing the checks, just printing them.

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