Market Update

After doing nothing the past few months (with the exception of the immediate reaction to Katrina), the path of least resistance appears to head higher. Granted, it is still too early to make a definitive call as we remain within the confines of a trading range that has dominated trading calls over the past few years—but it is at least a start.

Volume picked up across the board yesterday as the NYSE reported a daily turnover of over 2 billion. Brokerages and Internets paced gains as the early afternoon reversal managed follow through into the close, ending at session highs at 4pm.

Japan’s NIKKEI also reported its second busiest day ever as the index cascaded to multi-year highs once again. While I am still hesitant to look for a major move higher in the states, I would aver that Japan is out of the woods and on the right path. The great people of the island nation would be remiss not to give credit to industry and the man with the plan, PM Koizumi. The Prime Minister’s shakeup over the postal service gave him the mandate he needed and freed his own LDP party of the cronyism and nepotism that had dominated their agenda since the fallout of Japan Inc.

As previously stated, a buoyant Japanese economy tends to bode well for us and is a great coincident indicator of consumer sentiment. Hopefully this will translate to a strong 4th Quarter.

Also, we are in the process of making some much-needed upgrades to our web-log and we apologize for any inconvenience or disruption in service.

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Need some money? Need it soon? I have the answer to your problems—all you need to do is move to the districts of any of GOP leadership and you too can cash in!

What happened to fiscal discipline?

I am not opposed to deficits, being the U.S. is in the midst of a war and reconstruction, but at some point (now) lawmakers need to offset spending with some cuts. Yes it is difficult and yes it will upset some constituents, but it needs to be done.

Look at the highway bill. It is an egregious display of spending gone wild. Hundreds of millions of dollars are earmarked to go to everything from municipal parking garages to hiking trails. For one, these items have nothing to do with highways and infrastructure (the purpose of the bill). Secondly, in the face of back-to-back natural disasters it is prudent to rethink many of the unnecessary commitments and entitlements previously approved.

Republican leadership needs to put EVERYTHING back on the table and take their lumps. Yes, it may well be a PR disaster. Yes, it may well hurt them in midterm elections. But this is the reason they were elected, people were long fed up with the free-spending habits of their predecessors and gave them the boot.

Republicans used to view themselves as “outsiders” in Washington. I know President Bush did (and maybe still does). Maybe it is the water down in the belt. Maybe it removes inhibitions on voting for spending bills and throws caution to the wind. I don’t know. What I do know is the Republican Party has lost touch with its roots and is upsetting its fiscally conservative base.

Rick vs. Rita

It looks like Governor Perry’s prayers were answered over the weekend. Despite some damage to infrastructure and a massive inconvenience, Hurricane Rita did not deliver a second helping of disaster to the exposed gulf coast as many expected.

Much of Louisiana did re-experience flooding as the levees continued to provide ample evidence that their days of usefulness had long passed, touching off renewed fears of runaway federal spending and budget deficits as far as the eye can see.

Despite all the negativity dominating the news cycle, futures have managed to catch a bid this morning while oil continues its downward slide from Friday (there was also a special Sunday session).

Keep an eye on those trend-lines. My guess would be if we registered significant gains today, supported by higher volume that the trudge north would continue. Keep in mind, there is some technical damage that needs to be repaired, but sentiment has turned so decidedly negative that a decent rally seems more and more likely.

To Make Matters More Confusing…

The NASDAQ broke that first line, but managed to hold the old highs around 2100 yesterday.

While it is still too early to tell whether this is a top or if this action is merely corrective, keep your eye on the other indices, namely the S&P 500.

NASDAQ CHART

S&P 500 CHART

Peculiarly, the 90 day Treasury has also lost over 20 bps since the Fed meeting. Does the bond market know something we don’t?

Hurricane Rita has been upgraded and downgraded more than Google refusing to give guidance at a technology conference. As a result of the media coverage, I know I am not alone in considering building an Ark and grabbing 2 of every animal. Perhaps this is why lumber prices are soaring…

As earnings warning season approaches, fully expect companies to warn as a result of hurricanes and energy prices. Be especially wary of those that cut guidance when they have no exposure to either, like a doily reseller based in Oregon operating solely inside the Pacific North-West…

At any rate, have a good weekend and may Rita spare the gulf.

Гостеприимство товарищ

Loosely translated (into English from Russian), this means “welcome comrade” or “comrade welcome” –I am not too sure. What I am sure of, however, is a bill that is set to be introduced by Senator Byron Dorgan (D-ND) borders on communism harkening back to the days of the U.S.S.R. before its collapse.

This fine (Sic.) piece of legislation is aptly named “The Windfall Profits Rebate Act of 2005.” Essentially, Senator Dorgan is proposing a 50% excise tax on the windfall profits earned by major integrated U.S. oil companies on the sale of all crude sold that year. The money will be collected and subsequently distributed to every American Taxpayer. Senator Dorgan also kindly (Sic.) leaves room for the large energy companies to subtract drilling/ development costs and offer offsetting tax deductions for investments in renewable energy.

I have 5 major problems with this bill:

1. It is un-American and Anti-Capitalist. America is not in the business of punishing companies for making a profit. America is not called the land of opportunity for nothing. We encourage our citizens to take economic risks based on an economic reward. Anything that counters this fundamental principal puts Entrepreneurialism in jeopardy, which eventually lowers tax revenue and leads to larger deficits.
2. Income Re-distribution. This principle is at the heart of socialism. It is one thing to help those who need help via Governmental programs. It is quite another to take from one to give to another.
3. Define “windfall.” What exactly is a “windfall” profit? Is it a larger profit than historical norms? Is it a result solely of price-gauging?
4. Slippery Slope. If the government suddenly has the right to claim “unjust” profits from oil companies, what is to stop them from doing this to any other sector of the economy? This sets a dangerous precedent. I can picture a windfall tax on the Casino and Gaming sector next, as they generated profits in an “immoral” fashion.
5. Oil companies should not have to foot the bill for the reconstruction of the Gulf Coast, which seems to be the goal of this bill (other than satisfying Senator Dorgan’s need to hear himself speak). The Hurricane is not their fault, as much as environmentalists may try to make you believe. In fact, they will need their cash to rebuild their infrastructure along the coast (that was destroyed), build new refineries and to continually import raw crude to be refined in the face of higher rates as resources remain scarce.

I am no fan or friend of the energy sector. I am also no fan or friend of an intrusive government. This is not a case of choosing among the lesser of two evils, as I am sure it will be portrayed this way in the press (if they ever pick the story up).

I could understand the need for Congress to involve themselves (by this I mean form a sub-committee and grandstand) if gas prices were at current levels while the price of a barrel of crude was say $30 and price gauging was the result of collusion. But this is not the case. The reason the price is so high is because we cannot get enough into our ports, and even when we can—we cannot refine it fast enough.

Here is the link if you want to read it for yourself:

http://dorgan.senate.gov/legislation/windfallprofits/index.cfm


Please email me with any comments

Cut and Dry?

Things on Wall Street, much like Main Street are rarely what they seem. Yesterday I presented two lines on the NASDAQ which basically outlined what would happen if either were breached. At about 3:30pm yesterday, it was clear that the uptrend would not hold and the market would make a run south.

Here is what I am thinking: A short contraction is looking more and more likely. Nothing major, probably not more than a quarter (if that) and very shallow—probably in the ballpark of -.5 to -.8%

The economy did an incredible job of absorbing the oil price doubling, the cost of basic materials sky-rocketing and a somewhat tight labor market. Core inflation, as noted by the Fed has remained mild. But apparently the Fed sees equal risks to both the upside and downside of the economy as it chose to continue its tightening cycle.

In my opinion, the retail sector and/or any industry that would be affected by consumer spending will be hardest hit. Yesterday the S&P Retail Index closed down 1.8% as it cascaded through the August lows on news from companies like American Eagle Outfitters and Estee Lauder forecasting lower profits (as a result of gas prices and Katrina).

I would also be encouraged if the White House were to take steps to offset the Fed’s poor policy choice. First among them would be cutting spending. I read somewhere that there were 300+ “Pork Projects” contained in the Highway Bill that have zero to do with rebuilding infrastructure. The White House would be wise to placate Wall Street by pressing Republican Leadership to pass a streamlined version of this bill, and reallocate capital to the Gulf Coast.

Internationally, the Asian Economies look like they will close out the year on a strong note as the NIKKEI closed above 13000 for the first time since 2001 and the South Korean KOSPI index closed at an all time high.


Getting back to the chart, there is another outcome which should be shown, in case this is nothing but a shakeout (and I am totally wrong…).



NASDAQ CHART

W.D. Gann asserted that old highs become new lows in a bull market. We may just be coming down to test support/old high…only time will tell.

Decision Time

NASDAQ CHART

If there was only one thing I could watch over the very short term, it would not be the Fed, nor would it be Hurricane Rita. Of course I will be paying attention to those, but for the most part the action of the market will tell me all that I need to know.

If we break out of the top, my bullishness will remain intact.

If we fall out of the bottom, it will be time to face the bearish music.

Now I could be wrong here, but I think what the Fed and Hurricane are telling us could not be more plainly stated than by what happens over the coming sessions. Obviously if the Hurricane misses important infrastructure and the Fed chooses to end its tightening cycle (or at least indicates a willingness to take a “wait and see” approach in its policy statement) I would be inclined to believe that an exit north-bound is imminent. Any other scenario would surely increase the chance of a south bound departure based on the severity and impact of both.

The Fed and I

The Fed doesn’t know it (yet), but we have a love/hate relationship. I admire Chairman Greenspan and all he has done in his tenure (since 1986 both inflation and unemployment down, total of 5 contracting quarters of growth in 19 yrs), but sometimes I cannot feel anything but discontent for their policy and accompanying statements. This week is one of those times.

Greenspan and Co. feel obligated to raise rates. They are worrying about inflation. They are worrying about the spike in building material costs (since before Katrina, but more now than ever). They are worrying about higher gold prices, higher oil prices and higher transportation costs. In general, they are worried.

Just like any financial decision there are consequences for their actions, something often defined as “risk vs. reward” by financial guys like me. So if the reward for raising rates is clearly price stability, what are the risks?

One risk is an uneven and unsteady housing market. Raising rates will most likely drive mortgage rates higher and possibly constrict lending practices.

Another risk is the inversion of the yield curve. Without going into too much explaining, historically yield curves precede a recession 60% of the time. Greenspan seems to indicate that this is a non-issue this time around, but something worth watching nonetheless.

Another risk is the strain higher rates will put on consumers and business that have high debt covenants and maintenance requirements. As anyone with a high credit card balance knows, the percentage of finance charges of your monthly minimums have grown exponentially over the last few years. This also applies to corporations which traditionally maintain high debt levels—utilities, airlines, diversified industrials, etc.

Finally higher rates should stymie growth. They will also evoke fear among Wall Street member firms who seem to believe the Fed loves to raise rates until something “blows up,” as is often the case. Think Asian Crisis, Russian Crisis, Tech Bubble, etc.

So in a nutshell, the Fed will raise the benchmark rate. They have not telegraphed anything to the markets to make us think differently (Fed Funds futures predict an ~85% chance of 25bps).

Let’s hope the reward outweighs the risks…and as displeased as I may be, its difficult to stay mad at someone with that track record.

The Other Definition of Insanity

Someone once told me the definition of insanity was to do the same thing over and over, except to expect a different result. In my opinion, this is the only adjective that can be used to describe U.S. policy toward the airline industry, insanity.

Earlier this week the NY Times reported that Delta and Northwest were set to declare Chapter 11 bankruptcy protection. On Wednesday this was confirmed. To anyone who had kept abreast of the recent 8-k and 10-k filings from these companies, this should come as no surprise. In addition, anyone with a working knowledge of the economic history of the airline industry in the United States should recognize this as perhaps the greatest recurring nightmare in Corporate America.

We cannot continue this foolish practice. Why should survival of the fittest apply to every sector of our economy except this one?

Many people argue that we need to keep our airlines afloat—it is integral part of our infrastructure—affecting commerce, tourism and obviously travel.

So what? Every sector and industry is an integral part of our economy. The only difference is they are able to stay in business by doing what a good business should do: be competitive, maintain a lean cost structure, manage inventory and supply levels, innovate, and ensure labor is plentiful— things that the airline companies stopped doing DECADES AGO.

There is always an excuse—oil prices, labor unions, security upgrades, bond holders—they continually hide behind the guise of “unexpected surprises,” “unforeseen events” and “one time charges.”

I have news for you. If you run an airline, buying fuel, paying your pilots and meeting debt covenants is part of your everyday business, there is nothing special about them. So oil prices went from $35 to $65. This is a 100% increase in resource prices over the course of YEARS. They had plenty of time to adjust, streamline, raise prices—do whatever it takes to meet the cost increase. That is part of a business, fluctuating costs.

In the same period of time while oil has doubled, other commodities like milk and chicken have experienced similar (or in some cases greater) price increases. Should the U.S. Government bailout the restaurant industry?

Should Archer Daniels Midland (the largest U.S. farm) declare chapter 11 and wipeout all of their equity and debt holders and start anew every time cattle feed prices spike?
The biggest favor we can do for this sector, the American economy and the American traveler as a whole is not bail them out and not allow them the convenience of Chapter 11 every time they mismanage. No other enterprise is rewarded for mismanagement. The temporary disruption from consolidation that will emerge will pale in comparison to the billions of dollars in subsidies we pay these inept CEOs to throw away. In the age of deficits, wars and terrorism this behavior is simply unacceptable (this is not to say we should not subsidize security costs).

We cannot afford to make the same mistakes and expect a different result this time. As Joseph Schumpeter opined about the “perennial gale of creative destruction” in the 20th century, I am sure his thinking did not include the notion that any industry is beyond reproach. We need bankruptcy reform and to stop practicing flawed policy, for our economy will be stronger as a result.





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The opinions expressed reflect the judgment of the author as of the date of publication and are subject to change without notice.
This publication does not constitute an offer to sell or a solicitation of an offer to buy any securities. E1 Asset Management, Inc., and its officers, directors, and employees, and affiliates and members of their families may have positions in these securities and may, as principal or agent, buy and sell such securities before, after or concurrently with the publication.E1 Asset Management is a fully agency company and doesn’t seek any investment banking deals.

South by South-East

Unfortunately for the bulls out there, this has been the direction of the market over the last few sessions. The price action has been vicious, the retail-affected sectors have been pummeled and the bears seemed to wrest control of the major indices on some disappointing economic news and earnings.

While the volume has been far from overwhelming (and actually on the light side) that has not been much comfort for the longs. Some are yelping about historical September performance—the only month that has the dubious distinction of negative returns. Then Hurricane Katrina went from being a positive (focus on rebuilding) to a negative (focus on port troubles and drainage issues) literally, overnight. The economy has slackened off slightly more than expected. The fed has not telegraphed its willingness to put a halt on the increases, rather taking the view of the damage as a “transitory event.”

There are two ways to view this: new bearish trend, or a breather in the rally.

I happen to be in the camp of the latter. Very simply, as stated before, the consumption during the reconstruction effort will DWARF the capacity and/or output lost before the tragedy. End of story. The problem is the focus has been shifted on “who”(as in who will benefit)—clearly it should be on “when.” And the answer to that is 2006. But knowing the stock market operates as a forward pricing indicator should tip you off that these numbers will not be reflected in their current quarter or even year.

The only real qualifier will revolve around the supply-chain, specifically getting energy refined and moving the refined product to its endpoint. But once again, I am not so worried after examining the SPR data. Refineries have taken the U.S. up on roughly a third of the oil tapped. Many derided the Bush Administration for not making enough readily available—when the fact is the demand is not there.

Remember always, bull markets climb a wall of worry. Until proven otherwise, we remain in a bull market.

What is In and Out?

Unfortunately, our legislative body does not see tax relief as a priority. This does not include any new priorities, simply an extension of the dividend and capital gains reductions passed last term. Fortunately, however, the Bush administration is looking into the possibility of temporarily relaxing and/or eliminating any tariffs on building materials coming into the country.

The current tariff is merely an appendage of the former protectionist policies of our government that evolved over time to serve as a deterrent for foreign countries seeking to “dump” (in the sense of a WTO violation—see Japan and consumer electronics in the 1980’s) their goods on us. Because of the change in the global economy brought on by the industrialization of China and India, the U.S. no longer has to worry about protecting its companies from unfair pricing practices from abroad. Now, it is the consumer, inflation, and assurance of materials that is dominating trade policy rather than the underhanded tactics from before.

Relaxing or eliminating this measure will put a much needed first step toward a market decided by supply and demand, rather than the whims of the few in charge. It will also make it far easier to relax tariffs in other areas that need reform (mainly finished goods—textiles, electronics, etc.) and encourage other countries to follow suit. It is very difficult for the United States to pressure other countries on opening their markets (i.e. Asia) and not look in their own backyard—that is called hypocrisy. Since we are regarded as the world’s superpower economically, we must set a clear example (and showing how simple it is to do once the red tape is bypassed) and maintain a standard for others to work toward.

Tax relief is going to be spared simply to make the majority not look like they are pushing the country into an abysmal deficit after spending north of $100 billion on Hurricane Katrina.

Will it re-enter the domestic agenda?

Most likely. It really depends on the mood of the country in the aftermath of this disaster, the disposition of the G.O.P. come mid-term election time and the strength of the economy over the next 2-4 quarters. Only time will tell…





"The CRB remains in a clear up-trend channel (since 2003), mostly explained by higher global demand for basic materials in the cash market led by the U.S., China and India."

Grab the ____ by the Horns

Despite all the negativity swirling around the economy, oil prices, hurricane, government response, the yield curve; the market managed to put together a phenomenal week, closing up 2%. As been said before, bull markets climb a “wall of worry” and this has been no exception. Let’s look at a few of the positives confirming the positive outlook:

1. Natural Disasters. Oddly enough, the market (historically) tends to do quite well following hurricanes. This can be attributed to the amount of consumption involved in the rebuilding often outweighs the amount of capacity lost. Cold blooded, perhaps; capitalistically efficient—you betcha.
2. Energy prices. It would not surprise me to see when the NYMEX tables come out for august to see a well distributed oil contract, purely in the hands of longs, with a dramatic rise in the % owned by small speculators. This tends to be a reliable contrarian indicator (as often indicates there is no more demand) preceding large sell-offs.
3. Japan is the new…. Well, Japan. People love to call China the “new Japan.” It is simply not true, as there are few similarities in their political economies. Japan appears to be on track again (please refer back to my “Japan Inc. Blog” for a full outline) to pace Asian growth. This is a very good sign as Japan is a reliable indicator of U.S. growth—predicting a robust consumer will triumph.
4. Mr. Roberts goes to Washington. After the passing of Chief Justice Rehnquist (who will be missed sorely) the nation’s attention will focus on the Robert’s hearings beginning a new news cycle, one (hopefully) with a more positive bend.
5. The Russell Factor. For you who know Richard Russell, you are very aware of the ramifications of his shift from a negative to a neutral standpoint, leaving the door open for S&P 1250 and a bullish outlook. For those of you who don’t, look him up and fast.
6. The Yield Curve. Has not inverted yet. Inversion is economically dangerous historically, yet Greenspan tells us it simply doesn’t work anymore. As long as it refrains from snapping however, I think rates should be our friends.


SPX CHART



S&P 500 Breakout looms as index nears the all-important 1250 level.

$62 Billion and Counting

The cost of Hurricane Katrina has now exceeded $62 billion with the passage of the emergency spending bill yesterday, a number which only will be revised upward in the future. This surely will become a contentious issue, especially as early critics have begun comparing it to the money spent on Iraq—somewhat of a dubious distinction and a tip-off to the firestorm about to begin.

Why this number is important is very simple: the total cost of the recovery/stabilization/rebuilding in the Gulf will become a political football that could affect the stock market.

Very simply, the consequences of this issue reported by the press will be three-fold:

1. It will bring the deficit back into focus. This is clearly a negative for investor/consumer confidence. Despite the fact that as a percentage of GDP our deficit is among the lowest in industrialized nations—it does not make a good news story, therefore it will likely only be reported in The Wall Street Journal.
2. It will impact tax policy. Congressional Democrats will seize upon this opportunity to fight estate tax relief (which was on the docket before the tragedy) and making the Bush Tax cuts permanent. Last year the federal government collected record revenue as a result of the tax relief in place, failure to extend will clearly have a negative impact on the economy, business spending and the deficit.
3. Mid-Term Elections. While congressional mid-term elections are set for November 2006, it is never too early to start jockeying for position in Washington. In fact, the only thing one can hear over the din of cries from down south is the finger pointing going on in the capitol. Political opportunism remains a given, no matter what the stakes.

I will continue to update on this issue as more data becomes available.


SPX CHART



Market remains resilient in the face of catastrophe. S&P 500 registers buy signals as it moves back above the 50 day moving average. Potential retest of the summer highs in order….

Economic Diagnosis (and Prognosis)

The diagnosis for the U.S. (and global for that matter) economy in the wake of Hurricane Katrina is simple. Once again, we are at odds with Wall Street’s most formidable foe, the unknown.

Other than the imagery making the news-rounds falling under the penumbrae of chaos and anarchy, there is a general lack of information surrounding the disaster area. How much damage is there to the residential infrastructure? The energy infrastructure? Commercial zones? Industry? Warehouses? Ports?

It is all a large unknown. So let us start with what we know.

Right now the energy infrastructure (refineries, pipeline, storage, etc.) is operating at roughly 30% of capacity. There are still clear logistical problems refining crude and moving the refined products to their destinations. For the most part, these assets have been written off in the short term. But there is room for upside here, as many of these places have yet to be reached by humans and their status should remain more of an “unknown” than an “inoperable” right now. Once energy companies are able to ascertain the safety of their employees and provide the basics (food, water, shelter) we should see capacity restored to at least 65%+ without a major restoration/construction effort (in my estimation).

The second problem is the loss to GDP, which is being estimated in the area of about .5-1% presently. Between the loss to retail, travel, tourism, etc. I feel this estimate to be too conservative. I do not believe it will force the economy to contract; rather the initial shock should reduce it to 1-2% this quarter, clearly putting a damper on output.

The third problem is the official response to catastrophe or disaster by the government. Katrina really calls into question the methodology utilized in responding to any crises by the powers that be. Currently, problems are dealt with on a local (municipality and state) level, with deference to the federal government for support and/or assumption of rescue operations. Basically, the federal government relies on the local government to tell them what they need and literally require the local official to “sign off” on the matter before control is assumed. Seeing that everyone had a 4-5 day advance notice to the hurricane, this does not bode well for the unforeseen, mainly terrorism.


Despite all that is wrong, the economic prognosis is bright. New Orleans, the Mississippi Gulf and Alabama will be rebuilt. Jobs will be created, commerce will improve and slowly, people will return to their lives. In order to make this a reality, I believe three steps need to be adhered to:

1. The federal government needs to assume total control of the rebuilding effort, outline a plan with a timeline, and hand it over to the private sector.
2. The Federal Reserve should pause is its campaign to raise rates until they are able to discern the quantifiable impact of the Hurricane on the economy. I would presume this topic came up in the President’s meeting with Chairman Greenspan last week.
3. Tax cut. We need another growth stimulation package from congress. Federal revenues this year are at record levels as a result of the tax relief we received over the past 5yrs. This will help dampen the temporary blow to the economy and encourage further investment in the Southeastern U.S.

Hurricane Katrina

For those of you who have seen the early summer blockbuster “War of The Worlds” starring Tom Cruise, scenes from the Southeastern United States seem quite interchangeable with Speilberg’s interpretation of Wells’ fiction. The life lost, the utter destruction, the groundswell of anarchy, the seeming inability to get help to the area, the confusion of where to begin, the havoc been wrought on humanity. It is one of those few times in recent memory where pictures are worth a thousand words, as the price of our trials and tribulations as human beings has been their lives. Tsunamis, hurricanes, earthquakes, terror attacks…the new millennium has been a stark contrast to the “feel-good” 90’s many yearn for.


Despite the gloom and doom that persists throughout the world, there is a light at the end of the tunnel. I promise.

The horrible imagery seen on TV and in print will one day serve as a focal point and haunting reminder to those responsible for constructing policy and response to catastrophes of this magnitude.

It will force people to recognize the value of life and how quickly things can change.

It will show the charitable nature of the human race, always looking to help those who truly need it.

Finally, it will compel us to rebuild. That is what we do best.

Please do your part. www.redcross.org


Regular updates will resume Tuesday, September 6, 2005, following the Labor Day Holiday