The rally in oil off recent support just above $56 bl. to a tad over
$61 sets the stage for an important January for both the economy and
the markets. $61 bl. is no threat, but if this yearend upmove in oil
is the precursor to a strong seasonal rally, it will force some rethinking.
It has been my view for several months that the behavoir of fuels in
this first month of the new year will be important in casting Fed policy
and in setting confidence levels for a decent portion of 2006.
HAPPY NEW YEAR TO ALL.
Friday, December 30, 2005
Thursday, December 29, 2005
Economy in 2006 -- Short Version
As we roll toward '06, the inflation indicator for the short term is signalling
a continuing though less dramatic moderation than the Oct./Nov. period. This is
critical because with wage growth now up to 3.0% yr/yr, the real wage can recover a little. This sets the direction for consumer spending. I also believe housing activity
was shocked by the turmoil of the hurricanes and the spikes in fuels cost. Much
higher heating bills need to be taken into account. Even so, housing should recover
but progress will be modest. There is clear evidence of lost business sales, production
and employment in the wake of the storms. The hits were smaller than I thought they would
be, but bounceback potential is there for early in the year and release of nearly $70
billion hurricane damage relief will be a plus too. Overall the safest bet is to look for growth to accelerate off a flattish final quarter of 2005 and move nicely ahead into mid-year. There may be a slow quarter then, but I look for the year to finish out very strongly
because companies are going to have to begin to add some bricks/mortar capacity by then.
I am more concerned about 2007. Demand is outstripping capacity growth in the US, and
unless capacity grows markedly, the economy will begin to overheat. Profit growth in '06 should stay near 10%, although oil industry profit contributions could slip some as the year rolls on.
My biggest concern is with the continuing profound inflation in fuels costs. We are in a
seasonally quiet period now. Nat. gas is nearly $5 per mcf off its post Katrina/Rita peak
and oil is down $10. to $60 per bl. These are disappointing declines and leave me concerned
as we move into heating season. There is a decent consensus oil will average $54-55 a bl
next year. Devoutly to be wished for at this point. One also has to carefully monitor basic
grain and food commodities. These remain depressed and appear woefully overdue for some
positive price action.
My short rate cyclical indicators point to continued firming by the Fed ahead. Certain key
ones, such as the ISM manufacturing diffusion index have been far too strong to prompt a
let up. Moreover, with 3.0% inflation readings at several points this year, the Fed has no
business keeping short rates so low if they wish to see people begin to rebuild liquid savings.
As I have discussed in several prior posts, banks have been switching to offering jumbo
no or low reserve deposits to counteract Fed pressure on regular reserves. M-3 growth
has accelerated substantially to over 8% yr/yr. Not only will M-3 fund economic expansion,
it is well more than the real economy needs and will flow either into price or asset inflation. Uncle Al has the bubble machine on again, the old fool.
I plan to talk about the stock market in the next post or two. Many market prognosticators, mindful of the four year cycle low (year two of the presidential cycle) are jumping through hoops to find a basis for a hefty sell-off in 2006. As of now, I do not see it, but I have reserved one for 2007.
In all, if commodities do not run roughshod to the upside, it could be a decent year for
the economy/
a continuing though less dramatic moderation than the Oct./Nov. period. This is
critical because with wage growth now up to 3.0% yr/yr, the real wage can recover a little. This sets the direction for consumer spending. I also believe housing activity
was shocked by the turmoil of the hurricanes and the spikes in fuels cost. Much
higher heating bills need to be taken into account. Even so, housing should recover
but progress will be modest. There is clear evidence of lost business sales, production
and employment in the wake of the storms. The hits were smaller than I thought they would
be, but bounceback potential is there for early in the year and release of nearly $70
billion hurricane damage relief will be a plus too. Overall the safest bet is to look for growth to accelerate off a flattish final quarter of 2005 and move nicely ahead into mid-year. There may be a slow quarter then, but I look for the year to finish out very strongly
because companies are going to have to begin to add some bricks/mortar capacity by then.
I am more concerned about 2007. Demand is outstripping capacity growth in the US, and
unless capacity grows markedly, the economy will begin to overheat. Profit growth in '06 should stay near 10%, although oil industry profit contributions could slip some as the year rolls on.
My biggest concern is with the continuing profound inflation in fuels costs. We are in a
seasonally quiet period now. Nat. gas is nearly $5 per mcf off its post Katrina/Rita peak
and oil is down $10. to $60 per bl. These are disappointing declines and leave me concerned
as we move into heating season. There is a decent consensus oil will average $54-55 a bl
next year. Devoutly to be wished for at this point. One also has to carefully monitor basic
grain and food commodities. These remain depressed and appear woefully overdue for some
positive price action.
My short rate cyclical indicators point to continued firming by the Fed ahead. Certain key
ones, such as the ISM manufacturing diffusion index have been far too strong to prompt a
let up. Moreover, with 3.0% inflation readings at several points this year, the Fed has no
business keeping short rates so low if they wish to see people begin to rebuild liquid savings.
As I have discussed in several prior posts, banks have been switching to offering jumbo
no or low reserve deposits to counteract Fed pressure on regular reserves. M-3 growth
has accelerated substantially to over 8% yr/yr. Not only will M-3 fund economic expansion,
it is well more than the real economy needs and will flow either into price or asset inflation. Uncle Al has the bubble machine on again, the old fool.
I plan to talk about the stock market in the next post or two. Many market prognosticators, mindful of the four year cycle low (year two of the presidential cycle) are jumping through hoops to find a basis for a hefty sell-off in 2006. As of now, I do not see it, but I have reserved one for 2007.
In all, if commodities do not run roughshod to the upside, it could be a decent year for
the economy/
Wednesday, December 21, 2005
Interest Rate Scorecard
The comparisons discussed below are based on super long term rgression
models built around the 12 mo. moving average of the CPI.
With a CPI of 3.3%, the Fed Funds rate should be between 5.0 - 5.25%. The
Fed is bringing the FFR%, now at 4.25%, steadily higher, but it still
remains well short of where it should be. That short rates have been too
low for some time is well attested by a continued zero savings rate for
the consumer sector and the increased use of real estate based leveraging
techniques by same. To preserve domestic purchasing power, dollars saved
need to earn returns which greatly offset inflation and the income tax bite.
Homeowners have come to regard unrealized appreciation in home value as a
prime source of savings. This has been nice to have, but it is an unwise
practice since the great Baby Boomer housing boom is winding up to a close
now, and appreciation in home prices above the inflation rate will be ending.
By my models, the 30 yr Treasury should be trading around 6.375%. The market
is currently at 4.65%. The model value is a little high since Fed tightening
should lead toward a flattening of the yield curve, but, that said, The Bond
is still to dear in my view. There is insufficient premium for key long
term risk factors such as market volatility and a prospective rising supply
of new issues. I love trading the bond market but I have stayed away since
March, 2005 because I would prefer to trade bond volatility around fair value.
models built around the 12 mo. moving average of the CPI.
With a CPI of 3.3%, the Fed Funds rate should be between 5.0 - 5.25%. The
Fed is bringing the FFR%, now at 4.25%, steadily higher, but it still
remains well short of where it should be. That short rates have been too
low for some time is well attested by a continued zero savings rate for
the consumer sector and the increased use of real estate based leveraging
techniques by same. To preserve domestic purchasing power, dollars saved
need to earn returns which greatly offset inflation and the income tax bite.
Homeowners have come to regard unrealized appreciation in home value as a
prime source of savings. This has been nice to have, but it is an unwise
practice since the great Baby Boomer housing boom is winding up to a close
now, and appreciation in home prices above the inflation rate will be ending.
By my models, the 30 yr Treasury should be trading around 6.375%. The market
is currently at 4.65%. The model value is a little high since Fed tightening
should lead toward a flattening of the yield curve, but, that said, The Bond
is still to dear in my view. There is insufficient premium for key long
term risk factors such as market volatility and a prospective rising supply
of new issues. I love trading the bond market but I have stayed away since
March, 2005 because I would prefer to trade bond volatility around fair value.
Tuesday, December 20, 2005
Bond Market
10 yr Treas: 4.46%
30 yr Treas: 4.66%
As we near 2006, cyclical conditions for the bond market are
both negative and volatile. In addition there remains a good sized
coterie of bond players trying to handicap an economic slowdown
and presumed deceleration of inflation pressure. I conclude the
market is in a mild cyclical upturn in yields which may also feature
more occasional spikes both up and down in yield levels.
That conclusion above was brief enough, but one could easily write
on and on about the many "ifs" and nuances and shadings that could
be added to fully flesh out an intriguing picture. I will content
myself with just a few brief remarks.
The markets are neither overbought nor oversold.
Bullish sentiment, as measured by Market Vane, is still positive
at around 60%, but is hardly excessive. the best buying opportunities
come along when this gauge is down around 30%.
There is much speculation that the yield curve could invert. An inversion
would carry substantial forecasting weight if it reflected tightening
credit conditions. But credit conditions are still easy -- there is no
liquidity squeeze.
There is also intense speculation about when the Fed will end its firming
up of the FFR%. If that happens to be, say 4.75%, it could well turn out
that the Fed may maintain that rate for quite some time, in which case
players will gradually realize they may as well shorten maturities.
Looking longer term, the great bull market in bonds is technically still
intact as yield remains in a downtrend. There is an extensive base building
under the downtrend which could be signaling that the bull is coming to
and end, but it is still too early to conclude same. For example, the
case for an end to the bull would be more compelling if the long Treasury
yield takes out 5.00% and then 5.25% this year. We've a ways to go before
we come to those bridges.
30 yr Treas: 4.66%
As we near 2006, cyclical conditions for the bond market are
both negative and volatile. In addition there remains a good sized
coterie of bond players trying to handicap an economic slowdown
and presumed deceleration of inflation pressure. I conclude the
market is in a mild cyclical upturn in yields which may also feature
more occasional spikes both up and down in yield levels.
That conclusion above was brief enough, but one could easily write
on and on about the many "ifs" and nuances and shadings that could
be added to fully flesh out an intriguing picture. I will content
myself with just a few brief remarks.
The markets are neither overbought nor oversold.
Bullish sentiment, as measured by Market Vane, is still positive
at around 60%, but is hardly excessive. the best buying opportunities
come along when this gauge is down around 30%.
There is much speculation that the yield curve could invert. An inversion
would carry substantial forecasting weight if it reflected tightening
credit conditions. But credit conditions are still easy -- there is no
liquidity squeeze.
There is also intense speculation about when the Fed will end its firming
up of the FFR%. If that happens to be, say 4.75%, it could well turn out
that the Fed may maintain that rate for quite some time, in which case
players will gradually realize they may as well shorten maturities.
Looking longer term, the great bull market in bonds is technically still
intact as yield remains in a downtrend. There is an extensive base building
under the downtrend which could be signaling that the bull is coming to
and end, but it is still too early to conclude same. For example, the
case for an end to the bull would be more compelling if the long Treasury
yield takes out 5.00% and then 5.25% this year. We've a ways to go before
we come to those bridges.
Thursday, December 15, 2005
Monetary Policy
FF Rate: 4.25%
Cyclical factors that normally govern Federal Reserve policy actions
remain in firm uptrends and it is not difficult to posit another 25
basis point add on to the FF rate at the close of 01/06.
At this point, key factors such as manufacturing order rates and breadth
of same, factory operating rates and the balance between the supply of
loanable funds and short term loan demand all look positive going into
'06, but the momentum of these indicators may well slacken enough next
year to allow the Fed to call a temporary halt to pushing up the FF
rate after it reaches 4.75% or so. At this point, I do not see production
and loan demand growth as strong enough to warrant the Fed to move from
a newly minted "neutral" position to a squeeze.
The action of commodities prices in the seasonally strong winter months
will continue to rank high on the Fed's watchlist. The momentum of the
CRB commodities index has waned in recent months, but not by nearly enough
to give the Fed any comfort. Oil and natural gas prices in particular
remain sticky, and industrial commodities composites are moving higher
as well. The action in the trading pits over the next six weeks could
establish the FOMC meeting for late Jan. next year as pivotal.
I have been very confident about monetary policy and right on in my
thinking concerning same for nearly two years now. But, looking forward,
I find myself much more tentative and less assured about my projections
for rates and basic liquidity.
Cyclical factors that normally govern Federal Reserve policy actions
remain in firm uptrends and it is not difficult to posit another 25
basis point add on to the FF rate at the close of 01/06.
At this point, key factors such as manufacturing order rates and breadth
of same, factory operating rates and the balance between the supply of
loanable funds and short term loan demand all look positive going into
'06, but the momentum of these indicators may well slacken enough next
year to allow the Fed to call a temporary halt to pushing up the FF
rate after it reaches 4.75% or so. At this point, I do not see production
and loan demand growth as strong enough to warrant the Fed to move from
a newly minted "neutral" position to a squeeze.
The action of commodities prices in the seasonally strong winter months
will continue to rank high on the Fed's watchlist. The momentum of the
CRB commodities index has waned in recent months, but not by nearly enough
to give the Fed any comfort. Oil and natural gas prices in particular
remain sticky, and industrial commodities composites are moving higher
as well. The action in the trading pits over the next six weeks could
establish the FOMC meeting for late Jan. next year as pivotal.
I have been very confident about monetary policy and right on in my
thinking concerning same for nearly two years now. But, looking forward,
I find myself much more tentative and less assured about my projections
for rates and basic liquidity.
Monday, December 12, 2005
Stock Market -- Technical
S&P 500: 1260
I am impressed enough with the upwave in the market since October
to look for it to move higher, with the S&P 500 now expected to
rise to the 1310 area at some point well into January.
The move in the S&P from 1248 to 1268 over the week of 11/18 - 11/25
was a pleasant surprise but the sideways to down action since then
was not a surprise, as the market had become short term overbought as
indicated in the last technical comment on 11/19.
The impulse up during October and November was clearly strong enough
to warrant an extended consolidation, which could easily last another
week or two before we begin to run out of time in looking for a resumption
of the rally. I am also uncomfortable with the high degree of bullish
sentiment I see in the popular gauges such as Marketvane and Consensus,
so a brief continuation of the sideways/down bias might be in order
to reduce the head on this glass of beer.
If I have a more substantive bother, it would be in the intermarket
area where the charts for oil and the bond yield are no longer
so hospitable to stocks as during most of November. The tenacity of
oil around $60 has been a surprise as this is a seasonally weak period
for oil.
I plan to discuss the stock market more fully as we get a little bit
closer to 2006.
I am impressed enough with the upwave in the market since October
to look for it to move higher, with the S&P 500 now expected to
rise to the 1310 area at some point well into January.
The move in the S&P from 1248 to 1268 over the week of 11/18 - 11/25
was a pleasant surprise but the sideways to down action since then
was not a surprise, as the market had become short term overbought as
indicated in the last technical comment on 11/19.
The impulse up during October and November was clearly strong enough
to warrant an extended consolidation, which could easily last another
week or two before we begin to run out of time in looking for a resumption
of the rally. I am also uncomfortable with the high degree of bullish
sentiment I see in the popular gauges such as Marketvane and Consensus,
so a brief continuation of the sideways/down bias might be in order
to reduce the head on this glass of beer.
If I have a more substantive bother, it would be in the intermarket
area where the charts for oil and the bond yield are no longer
so hospitable to stocks as during most of November. The tenacity of
oil around $60 has been a surprise as this is a seasonally weak period
for oil.
I plan to discuss the stock market more fully as we get a little bit
closer to 2006.
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