August 9, 2010

The stock market initially declined on Friday's jobs report, but then it closed down just 0.2% for the day and UP 1.8% for the week, so Wall Street wasn't too surprised or shocked by the jobs report. In addition, earnings continue coming in strong, and Wall Street is starting to smell "change" in the air, as mid-term elections approach. Historically, the mid-term Congressional election rally starts no later than the end of September. Traditionally, that rally lasts an average 26 months - through the 2012 Presidential elections.
 
The big news last week was Friday's July payroll report, which reflected a loss of 131,000 jobs. However, that breaks down into 71,000 more private-sector jobs and 202,000 fewer government jobs. Most of the lost governmental jobs (143,000) were census workers, while most of the rest (about 50,000) were state and local government jobs tied to the 2009 stimulus package, which provided federal funding for these jobs during the first year only. Since states are running out of funds, those jobs had to be cut. The best news was that 36,000 new manufacturing jobs were created in July. The bad news is that the unemployment rate stayed stubbornly high, at 9.5%. At the current pace of private sector job creation, the jobless rate may not decline to pre-recession levels until 2015 or later. The bottom line is that if the U.S. economy is to continue recovering, then the private sector must continue to lead the way in jobs growth. There was another important economic announcement released last week. Each of the Big 3 automakers reported higher vehicle sales for July. Interestingly, both Honda and Toyota reported July sales declines, so the Big 3 could be staging a comeback.
 
While the federal stimulus is not working very well in the U.S., Europe's fiscal austerity appears to be working to some degree. There was a lot of encouraging economic news coming from Europe last week. First, the German auto industry continues to grow, thanks to rising exports to Asia. BMW, for instance, announced a six-fold earnings increase. Also, the June French budget deficit was 24.2% less than June, 2009. In addition, the European Union (EU) noted that Greece has met all its targets under the austerity plan drafted by the EU and the IMF. Finally, on Friday it was announced that Italy's second quarter GDP grew 1.1% vs. the same quarter in 2009. So overall, Europe seems to be getting its fiscal house in order, which may explain the euro's tremendous strength in recent weeks, as it has surged from $1.22 to $1.33 against the dollar.
 
The euro is not necessarily "strong" in its own right, just in comparison with the sinking U.S. dollar. I had a meeting last week with Jeff Auxier (Auxier Focus Fund), who explained that there are four ugly currencies dominating world commerce now, namely the British pound, euro, Japanese yen and U.S. dollar. He went on to explain that the U.S. dollar is the ugliest of these four major currencies, since we have not implemented any serious austerity cuts. As a result, he boldly told me that he felt the euro would hit $1.40 against the U.S. dollar before the end of this year. With the U.S. dollar declining, China continues to try to diversify away from the dollar by investing its massive trade surplus in other currencies and in key commodities, like copper and gold. In fact, China recently increased the number of banks it allows to trade gold bullion internationally and within China. China is now the world's #1 gold producer and the #2 consumer, after India. Internal demand is so high that China imported 31 tons of gold last year. Total investment demand within China hit 73 tons last year, vs. just 18 tons in 2008. Rising gold demand in Asia is one reason gold recovered to $1205 last week. A weak dollar also causes other commodity prices to rise in dollar terms. That is why crude oil prices are now back above $80 per barrel for the first time since May. Crops are also priced in U.S. dollars, so the price of wheat and other foods are rising sharply. Additionally, the extreme heat in Russia has ruined at least a fifth of their wheat crop and the Ukraine is experiencing similar problems, so the price of many crops have soared, with wheat rising nearly 50% in just the last two months. The good news is that a weak U.S. dollar and rising food and energy prices should put an end to all the talk about deflation. At least for the next few months.
 
On Friday, the jobs report stole the headlines, but in the bond market Friday's interest rate on two-year Treasury notes sunk to an all-time low of 0.494% before closing at 0.514%. The benchmark 10-year rate hit 2.82%, the lowest point since the financial crisis of early 2009. Low rates are one more factor pulling the dollar down, as investors seek higher returns in other currencies. These low Treasury yields give the Fed no choice but to return to printing its way out of the federal government's massive budget deficit. Since the U.S. finances approximately 90% of its massive $13 trillion debt with Treasury bills and notes yielding under 1%, the Fed probably cannot raise rates without causing the federal deficit to spin out of control.
 
In Europe, by contrast, rates are likely to rise soon. Both the Bank of England and the European Central Bank (ECB) kept their key interest rates unchanged last week, but most observers expect higher euro-zone rates, due to rising inflation in Europe. Specifically, euro-zone inflation ran at a 1.7% annual pace in July and if it breaches the ECB's annual target rate of 2%, the ECB could raise key interest rates soon.
In conclusion, it still looks like there will be no "double dip" recession in the U.S. economy. The job situation is still disappointing, but the U.S. savings rate rose to the highest level in a year, creating pent-up demand for consumer spending whenever consumer sentiment/confidence returns to more normal levels. When that happens, I expect that consumer spending to perk up substantially. In the meantime, we will probably continue to see a painfully slow recovery.  
 
Have a nice rest of the week.

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