The Week Ahead 8/11/08

Once again this week is shaping up to be a great "trader's" market.  A bunch of economic data, the Russian attack upon Georgia followed by claims from Georgian officials Russia targeted the pipeline carrying Russian oil through Georgia to the west, and another busy earnings week should provide a good deal of volatility in equities, currencies, and commodities led by crude oil.  If we discover come Monday morning Russia did in fact attempt to hit, or did hit the Georgian pipeline, that will certainly halt the sell off in crude and send it back towards $120 a barrel.  Given the current high correlation coefficient between the price of oil and the value of the US dollar against the Euro we can expect the dollar to give back some of it's gains from last weeks aggressive rally and weaken back towards 1.5350 against the Euro during trading on Monday. 

On the data front the markets will get a look at trade data, inflation data, the foreign appetite for US financial assets, a peek at manufacturing, unemployment, and a sense for how we are spending our money and feeling about it. 

Retail Sales and the CPI data for July, Michigan Consumer Sentiment for June, and Initial Unemployment Claims for the week ending 8/9 should get the most attention from market participants. 

As always, I offer the standard caveat and cautionary notes to traders:  "It's all about expectations" when it comes to economic data with those in data least well forecast inducing the greatest volatility; watch any revisions to the prior period; and keep an eye on the news headlines. 

Article of Interest:   George Will:  A Century of Progress in America

FRANK ON UNEMPLOYMENT RATE:  Be afraid, be very afraid.  Financial markets are now anxious about a rising unemployment rate having spiked up to 5.6 percent (a rate still historically low and at or around full employment) over the past two months from a calm 5.1 percent as measured by the Household Survey conducted by the Bureau of Labor Statistics (BLS).  Recently, the BLS picked up a bunch of teenagers and college students voluntarily entering the labor force by indicating their efforts to find a job during the survey week.  This meant America's labor supply increased but the number of employed did not match the increase.  Hence, a higher unemployment rate.  It is the labor supply calculation, the number of those employed plus those who are unemployed but are actively looking for a job, which is the villain here.  Those who are not looking for work but are unemployed (often called discouraged workers) are not included in the labor supply.  Many economists suggest if the labor supply numbers were more honestly calculated to include all Americans of working age who are able and wanting to work, the unemployment rate for the US economy would be approaching 9-10 percent.  Of course politicians have their hands in the mix and are complicit the deception.  Once we get some honest courageous elected officials in Washington DC we will have to be honest with ourselves and recognize America's economy has some bigger problems than those in office today are willing and able to admit.   On that day, get short equities and long bonds, because the reaction this past Friday will be a blip on the chart when compared to price action we'll see on that coming day.  

FRANK ON IRRATIONAL MARKETS:  Neo-classical economics has one very large assumption underlying the whole theory: rational behavior.  It's a necessary assumption upon which to attempt to predict human behavior when it comes to consuming and participating in the ebb and flow of financial markets.  What we are witnessing in terms of the price action of crude oil, the value of the US dollar, and equities in the past weeks, particularly last week on the back of comments from the ECB on Thursday and the release of the Employment Situation Report for the month of May on Friday, is clear evidence of how the basic assumption highlighted above can be turned on it's head by irrational behavior.  Trading in any financial product is based upon two things, fear and greed.  Either one when the dominant sentiment create unusual volatility and general market activity.  Fear is the dominant sentiment at the moment, particularly among those participants who are betting the price of oil is overdone to the high side.  What we witnessed last Friday with the $16 dollar jump in the price of crude oil was the power of fear as those short crude (betting it's going lower) were forced to scramble to cover their short in a fast moving market against them.  What triggered the fast moving market up?  More irrational market behavior motivated by fear and uncertainty.  Hawkish ECB comments on interest rates, and an unexpected jump in the unemployment rate in the US for the month of May triggered the rally.  But, it should not have if most of the acting participants were able to act in a rational manner.  Such is not market sentiment though.  In fact, higher rates in Europe and higher unemployment in the US are indicators of slowing economies to come and suggest lowered demand for crude...not higher.  Traders of oil, the US dollar, and the S&P have got themselves all caught up in the hair brained notion that the weaker dollar is positively correlated to the price of crude.  Of course economic theory teaches us in the current event, these are not correlated events as being implied by market price action.  Particularly when one keeps in mind the price of crude is generally priced in US dollars.  Therefore, as the dollar weakens, oil should sell off as demand for oil stabilizes or diminishes in the face of higher prices for the consumer.  Additionally, since oil is priced in US dollars, and the dollar is weakening against the EUR and the JPY, then the inflationary impact on those two regions is significantly less than that on the US dollar.  We  are in the midst of fear dominating the actions of market participants.  We will continue to experience significant volatility, and overshooting to the highside both for oil and the sell off of the dollar.  It's the cart and the horse problem amongst the three trading products.  US dollar traders are watching oil and the S&P's for their cures on trading, oil traders are watching the US dollar, and S&P's are watching the US dollar and oil.  It's a circular frenzy made more so by the ubiquitous presence of digitized algorithmic trading models.  Rational actors will once again assert their control over price action, but only when the dust settles, which will be some time still.  Although, all must be reconsidered if Israel attacks Iran in a surprise attack, or if Obama wins and we get his socialist fiscal policy.  At that point, it's 1973 all over again.         

FRANK ON Q1 GDP, RECESSION?: The financial markets got their second look at Q1 GDP for the US economy.  Upon revision, Q1 GDP came in at a .9 percent growth rate, about three tenths of a percent better than the market was expecting.  So, recession, or no recession?  Well, the answer is both yes and no.  It depends on which region of the country you reside.  Think of GDP as essentially an average of growth rates from all 50 states.  If growth is .9 percent nationally, that implicitly means some regions may be growing near 2 percent, and some contracting by 1 percent.  What is important to watch for in this data is the second derivative (the rate of change of the rate of change).  It's very likely across the whole country, the second derivative is negative.  Detroit for example, is clearly in recession as growth is contracting, but still more important is the second derivative is also still negative, which means Detroit's economy is contracting at an increasing rate (read still getting worse).  On the other hand, New York City is still growing above the national average of .9 percent, but without question the second derivative is negative.  For New York City, the economy is increasing at a decreasing rate, which means it's headed towards zero or negative growth.  Like politics, economics can be all local.  In slow growth times, there is always some region of America in recession.  

FRANK ON LOSING BUD AND THE FRIG TO KEEP IT COLD:  Is there nothing sacred for Americans anymore?  How is it two of America's greatest brands and household names can be so easily cast off to foreign ownership with nary a whisper except a few headlines from the business pages.  Apparently, Anheuser-Busch is subject to a takeover, and GE's appliance unit has a big for sale sign on it.  GE, always the margin snob feels the appliances business is beneath it now (Or, as Jeff Immelt is known for saying, "if someone can do it better than we can...").  Since, due to decades of bad trade policy and a-national consumption habits of many American's today, Asian and European appliance manufacturers have been steadily eating away at GE's appliance market share over the past 15 years.  Faced with shrinking margins from stiff competition, and a balance sheet rocked by poor bets within the GE Financial group over the past year, GE is abandoning a great American brand and taking another little bit of emblematic pride away from American patriots.  It should come as no surprise to learn GE is making no effort to keep GE Appliances in American hands...the leading bidder is LG from South Korea.  Say goodbye to another US manufactured product.  ANHEUSER-BUSCH (Bud, Michelob, Rolling Rock, Busch, et al), a great American brand, is in the sights of Belgium brewer InBev (a sub of AmBev of Brazil).  Little tiny Belgium, taking over an American icon like Bud...can that be?  The weak dollar, a tacit understanding between European and American officials American assets are up for sale in an effort to further diminish that pesky little patriotism problem America has always had, and a-national CEO's and institutional shareholders ready and willing to sell to the highest bidder, are the basic reasons.  What is alarming to me is how easily deals like this occur today.  Once we were owners, now we are owned, and that cannot lead to good things for America in the future.  Doesn't anyone care anymore? Note:  On the appliance front, we've already lost Maytag to Sweden's Electrolux.   As for brewers, Miller is now owned by the South Africans and Coors is now owned by the Canadians.  Bud is all "Buy American" Americans have left. 

FRANK ON OIL:  Commodities generally, led by the price of crude oil, are in a price bubble.  Unlike what T. Boone Pickens said yesterday on CNBC, there is at least $30-$40 worth of speculation in the price of crude oil.  Yesterday, T. Boone, having said that there is not one dollar of speculative push on the price of oil, in the next breath told CNBC he is now long oil after having been short to start the year.  That my friends, is the definition of speculation.  And like T. Boone, thousands of others individuals, be they trading on their own account, working in the Capital Markets group of any of 50 banks and investment banks around the world, or running a hedge fund, are speculating on where the price of oil is going.  Their motivation, higher incomes via bonus compensation or capital gains.  Right now, they're all in the same boat convinced it can only go higher.  As evidence, consider this:  The price of a barrel of crude has jumped over 20 percent in the past week.  Is their anyone who believes demand for oil in that same time jumped 20 percent?  No, I didn't think so.  More evidence: Two weeks ago a Goldman Sachs analyst predicted the price of crude would reach $200 a barrel in the next year.  What happened next, oil traders took the price of oil higher on that news alone.  Why?  Because that's what your supposed to do when it's going higher?  Isn't it? It is speculation.  The herd is running right now, and for the moment in one direction.  It won't run the same way for much longer.  WHAT'S THE FIX:  The fix is easy.  It's battling the environmental left (read NGO's, nearly all of Congress and most governors) which is the hard part.  Here is what must be done to get back on the path to some sort of reasonable national energy policy.  First, stop the push on corn based ethanol.  It's not cost efficient at this time and it's creating tremendous upward pressure on food prices globally.  Not to mention the fact the motivation for corn based ethanol mainly comes out of short term political campaigning as Iowa is the first state on the political election calendar.  Second, reopen the Rocky Mountains to natural gas and coal exploration.  Bill Clinton signed an executive order during his second term putting coal exploration in the Rocky Mountains off limits in a deal with China.  Third, open up the eastern seaboard to oil and natural gas exploration.  The quick response to this one is fear for any accident's impact on tourism along the South Atlantic coastline.  You know what else will be bad for tourism there...$10 a gallon gas, stagnation, geopolitical instability.  Forth, reduce government regulation pushed by the environmental lobby for decades related to the construction of refineries and nuclear energy plants.  Lastly, to all my fellow citizens, the NIMBY thing has got to stop.  Not In My Backyard can't be the reason we consign a significant portion of our fellow citizens to unnecessary hardship.  Note:  The best our elected officials have come up with for this problem so far is a tax holiday.  WARNING, WARNING...we need new elected officials. 

FRANK ON CLINTON CAMPAIGN:  Hillary is not going to be the nominee for the Democrats unless she wants to create an historic level of chaos at the convention.  Right?  We all know this.  Yet, she fights on.  And, OK, do what you will.  I'm sure she has some contrived motivation related to her future political fortunes in mind.  The only point I want to make today relates to her campaign finances.  According to just released records her campaign is $30 plus million in debt.  Shouldn't this be a barometer for the success of any Presidency she may have had.  How can she be President if she and her team can't manage the finances of her campaign.  Which is to say, her judgment on expenditures when constrained on the revenue side is poor.  Just what she would confront with the federal budget.  She's a compromised 20th Century American politician, and enough of them already.  Of course that leaves with John McCain and Obama.  Not good.        

froche@frankroche.org