The "D" Word

Geez, the cat is finally out of the bag.

No sooner does Federal Reserve Bank of St. Louis President James Bullard utter the word "deflation," then the whole market gets all quivery and queasy. It's as though nobody wants lower prices or even a temporary restraint on runaway excess credit expansion.

Well, here's the news: We've been experiencing deflation - depending on how loosely you wish to interpret the definition - since about August of 2007.

Really? You ask, stunned by not being aware of current financial conditions. Yes, really, since August, 2007, like three years, when stocks began to deflate (or, go down). And real estate prices deflated. Remember when they called residential real estate prices a bubble? What happens when you prick a bubble? It deflates. If there's any indication of deflation, just ask homeowners in vast areas of California, Michigan, Florida or Nevada, where home prices have fallen by as much as 60% or more.

Technically speaking, there are two definitions of deflation, though since economics is more art than science, the two are often blended into one, such as this definition from Investopedia: "A general decline in prices, often caused by a reduction in the supply of money or credit. Deflation can be caused also by a decrease in government, personal or investment spending."

Over on Wikipedia, deflation is described as. "a decrease in the general price level of goods and services." Pretty simple, and correct, though some economics adherents will insist that deflation is a decrease in the supply of money.

There are very good discussions on both of the above linked references, and each of them makes salient points which overlap and intersect in such a way as to make my argument - that we've been in deflation since August, 2007 - pretty darn accurate.

So, let's take a look at conditions since the summer of 2007, and see how we Americans are doing on the deflation scale. First, we know that houses aren't as expensive as they were back then, so the residential housing market is definitely deflated.

How about other assets, like stocks? Well, the Dow Jones Industrials were tickling the 14,000 mark back then, and are barely able to maintain a level over 10,000 today. Sounds like about a 30% deflation there.

Here's one nobody gets: wages, which haven't generally risen since 2002 and even before that were pretty stagnant. So, if you're an employer, you like deflation - or, at least stagnation - in the price of labor.

As for money supply, it may have been increasing, though according to these charts from Shadowstats.com, the rate of growth of the various popular money supply definitions (M1, M2, etc.) seems to have been slowing, so that would qualify, technically, as "disinflation," not deflation. Hey, I can't be 100% right all the time, no?

And, lest we forget, the Spring and Summer of 2008, when gasoline prices hit upwards of $3 and $4, so, since everything doesn't all go down at once, and some prices actually have gone up (like gold, or silver), I believe it's safe to say that deflation has been the dominant economic theme for the better part of past three years.

If you're unconvinced, just try raising prices on consumer goods and see how quickly your customers will become those of your competitors. Deflation, while it isn't an evil thing (in fact, it's probably preferable to inflation), is not regarded as generally good for businesses, especially the kind whose stocks are traded on Wall Street, who have to keep increasing their profits every quarter, which, when you think about it, is a pretty absurd concept. Most people who own small businesses are fairly happy just making the same profit over and over and never becoming billionaires, just "comfortable."

Deflation really scares the bejesus out of Wall Street types and with god reason. The companies they hype will die in a prolonged deflationary environment.

As for how the markets responded to the dreaded "D" word, the response was rather muted. Being fairly bright people, many traders already know that deflation has already been in effect for some time, and they also don't jump the shark and sell everything on the word of one Fed President, so the markets did a little dip, then rose, then sold off at the close, producing a chart probably more closely related to fears of what the second quarter GDP estimate will be tomorrow morning than anything else.

Dow 10,467.16, -30.72 (0.29%)
NASDAQ 2,251.69, -12.87 (0.57%)
S&P 500 1,101.53, -4.60 (0.42%)
NYSE Composite 6,994.57, -4.61 (0.07%)

Advancing issues barely beat decliners on the day, 3296-3093, and new highs continued to dominate new lows, 280-85. Volume was better than average.

NASDAQ Volume 2,332,617,500
NYSE Volume 5,247,904,500

The forces of deflation seemed to have little effect on commodities. Oil surged $1.37, to $78.36 per barrel. Gold was up $8.10, to $1,170.50 per ounce, with silver gaining 18 cents, to $17.62.

Initial unemployment claims came in slightly lower than the previous week, though still unacceptably high, at 457,000.

The first estimate of second quarter GDP will be announced at 8:30 am on Friday.

Trend is Lower for US Equities

Stocks gave back some of the outsize gains of the past two weeks in another sign that the summer rally is at an end. Earnings reports are dwindling down, though a few key companies are still releasing figures. For the most part, however, investors are looking beyond the earnings numbers and taking closer inspection of overall economic data, like this morning's June Durable Goods report showing a 1.0% decline after a downwardly-revised 0.8% drop in May.

That report put a pall over the markets and stocks struggled throughout the session. Most of the losses came after the release of the Fed's beige book at 2:00 pm, which confirmed what many already knew: the US economy is slowing down, though not yet experiencing negative growth. With this weighing on the minds of investors, some were quick to take profits, though there still seem to be plenty of buyers keeping stocks at elevated levels.

Dow 10,497.88, -39.81 (0.38%)
NASDAQ 2,264.56, -23.69 (1.04%)
S&P 500 1,106.13, -7.71 (0.69%)
NYSE Composite 6,999.18, -45.81 (0.65%)

Declining issues held their edge over advancers for the second straight session, 4357-2048 (2:1), though new highs continued their advantage over new lows, 203-68. The divergence, not only in the high-lows vs. the A-D line, but also in the relative out-performance of the Dow over the NASDAQ, signals a good deal of confusion in the markets, and the markets generally don't appreciate confusion. Tops on the list of confusing issues is the decoupling of listed companies from the US economy. Companies have shown strong performance in their most recent earnings reports, but all of the US economic news has been on the sorry side. This is emblematic of US-based companies actually deriving major portions of their revenue offshore, particularly in Asia and Latin America, two areas which are on the opposite side of the Euro-Us debt collapse.

NASDAQ Volume 1,865,542,625
NYSE Volume 4,554,030,500

Adding to market woes was the announcement - late in the day - by California Governor Arnold Schwarzenegger that the the Golden State was now in an official "state of emergency" triggering an executive order which calls for state employees to begin mandatory 3 day per month furloughs without pay starting in August.

The issue is the state's $19 billion budget shortfall, and the legislature's unwillingness to bring spending and revenue into equilibrium. With states across the country gearing up for fall semesters of schooling and teacher unions refusing to budge on key wage and benefit issues, California has effectively fired a warning shot across the collective bows of state capitols, many of which are facing serious budget shortfalls and intransigent government worker unions.

The commodity space was unsettled as well, with oil down again, by 51 cents, to $76.99. Gold gained a paltry $2.40, to $1,160.40, while silver declined 20 cents, to $17.42.

Market inconsistency should come to a head by Friday, when the government releases its first estimate of second quarter GDP prior to the opening bell. Thursday's initial unemployment claims will also be closely watched.

Dull Summer Session May mark End of Rally

With the passing of the Tuesday session, it appears that the recent rally in stocks has pretty much run its course. More than 75% of the S&P 500 companies having already reported, there are fewer opportunities for quick scores on earnings rises and investors are now looking seriously forward to Friday's initial estimate of 2nd quarter GDP due to be released prior to the opening bell.

Now that the European credit crisis has been put down for at least a nap, the market has been able to focus on earnings for much of the past two weeks, and the results are obvious. All of the major indices have experienced significant bounces since the start of the month, with gains in the range of 7-9% overall.

In particular, the Dow is up a whopping 850 points since its interim bottom on July 2nd (9686.48), though it is still some distance from the most recent high of 11,250 in late April. While the major averages have all found comfort zones above their respective 200-day moving averages, chartists will note that criss-crossing the 50 and 200-day MAs are not uncommon circumstances, especially in periods of economic uncertainty, like the current markets conditions.

Thus, it's unsurprising that many analysts are taking a rather dim view of the currently-stalling rally, seeing it as transitory and temporary. After all, markets became severely oversold by the end of June, and perceptually, stocks were cheap, even if they remain well above traditional norms.

Projections for what the government will report 2nd quarter GDP as are all in the range of 2.3 to 3.5% annualized growth, which would be a slowdown for the second straight quarter, and therefore, not helpful in alleviating stresses over a return to recession. With just about anyone who matters already resolved on slower growth for the remainder of 2010, it's difficult to imagine stocks breaking to new highs any time soon. The rational bet is for the major averages to continue trading in the same ranges that have prevailed since last October, though risk is skewed to the downside quite prominently.

Dow 10,537.69, +12.26 (0.12%)
NASDAQ 2,288.25, -8.18 (0.36%)
S&P 500 1,113.84, -1.17 (0.10%)
NYSE Composite 7,044.99, -1.01 (0.01%)

Declining issues held sway over advancers, 3618-2812, but new highs ramped far ahead of new lows, 401-63. Volume was slim.

NASDAQ Volume 1,940,649,125
NYSE Volume 5,330,884,000

Part of the reason for Tuesday's lackluster performance can be tied to consumer confidence, which fell again in July, to 50.4, from an upwardly revised 54.3 in June. The dour outlook by consumers is keeping a lid on prices and profits.

Commodities seemed to have been struck with liquidity issues on the day. Crude oil for September delivery fell $1.48, to $77.50, but continue to be range-bound, between $70 and $80 per barrel.

Gold was zapped lower by $25.00, to $1,158.00, it's lowest price in three months. In concert, silver dropped 57 cents, to $17.62.

Companies reporting strong earnings included DuPont (DD) and Cummins (CMI), both of which beat earnings and revenue forecasts.

The prolonged slump in residential housing and employment continue to weigh on the minds of consumers and investors alike.

Euro Stress Tests a Joke and Wall St. Loves Them

Apparently, according to the central bankers of the world, and especially those in the US and Europe, banks are well enough capitalized to easily survive any kind of future monetary event.

That was the official word from Europe, where it was announced today that only seven of 91 banks in the region failed the European Union's stress tests. The other 84, for the most part, are not only well-capitalized, but strong, vibrant and growing.

After much hand-wringing and posturing over the past four months and with the goading and encouragement of not only Treasury Secretary Tim Geithner, but Fed Chairman Ben Bernanke (who, incidentally is currently on a visit to Europe), Europe followed the lead set down by its American counterparts in 2009 and conducted their own rather flimsy and opaque tests to determine how the largest banks in the region might fare under certain - supposedly bad - economic conditions.

The tests, as in America, revealed very little about banking in the Eurozone. Except for giving European leaders and banking executives a little more breathing room by taking media focus off of them, the stress tests were designed wholly to persuade the general population that all is well in the world of global finances, which begs the question, "why all the fuss in the first place?"

In the broadest, most general terms, what the conduct of the combined central banks of the nations of Europe and the US, plus the mega-banking operations scattered around those countries shows is that the entire financial calamities of the past two years were either made wholly of flimsy cloth or that the economies of many of these nations, and the USA, are in perilous conditions.

Choose whichever poison suits you best, but keeping the banking system and sovereign debt structures at status quo is probably grand for bankers - for now - and pretty much meaningless - for now - for the general populations. Later on, within months, most likely, the truth shall be exposed for all to see, that the nations and their central banks have been painted into a liquidity corner from which many cannot escape without severe austerity measures or default on scads and scads of debt.

With an entire global structure built upon fiat money with nothing to back it except a nation's good word, the eventuality of final collapse is assured, the only remaining question being a matter of timing. The politicians, bankers and associated ruling class participants will keep the charade going for as long as they can. In the meantime, in towns and cities and states across America and across Europe, the dismantling of the middle class will continue apace. Credit cannot and will not be extended to anyone with less-than perfect credit histories and sufficient collateral. Major corporations will continue to flourish at the expense of smaller rivals. Stocks will head up, and then down, and then repeat the pattern. Slowly, almost imperceptibly, the structure of governance and the prosperity of individuals will fall prey to the ravenous appetites of massive governments and business structures working hand-in-hand.

All that one can hope for under these conditions is for a continuance of the deflationary spiral which has been fought at every chance by the central bankers, though mostly in vain. Some of the largest economies in the world continue to limp along with interest rates at or near zero and credit choked off to the general public. Obfuscation and new regulations will only serve to exacerbate the situation until the populations finally give up or rise up.

In Europe, surrender is not so easily assumed. In the United States, it is almost certain, except for a very small percentage who will fly under the radar of the government, skirting the laws and rules, until they too are caught in the widening liquidity trap.

It's not a pretty picture going forward and it may take years to fully play out, but the absolute scurrilous nature of Europe's attempt to mollify the public is handwriting on the wall, writ small, but with larger implications.

As for Wall Street's role in the continuing dance of fools, stocks waited patiently on Friday, hugging the unchanged mark until after the stress test results were released. Once assured there would be no serious blow-back, the major indices took off on a tear toward and beyond their 200-day moving averages, as presaged right here on these pages in yesterday's post.

After the results were announced, traders took a few breaths, some supposedly went out onto their terraces for a smoke, and when they resumed trading, about 12:45, proceeded to take stocks higher in a hurry, pushing the Dow Jones Industrials up more than 100 points in the nest 45 minutes. The die already cast, the trades were executed.

All closed higher, and especially important, the S&P 500 finished the week above the 1100 mark, yet another sign that there's absolutely nothing to be concerned about. Your jobs are safe, your pensions in good hands, with the government and the Masters of the Universe on Wall Street continuing to monitor the health of your and your children's portfolios.

If it wasn't for all of this being so neatly wrapped up on a glorious summer Friday afternoon, one might presume that it was all preordained, completely organized right down to the final neat detail.

Dow 10,424.62, +102.32 (0.99%)
NASDAQ 2,269.47, +23.58 (1.05%)
S&P 500 1,102.66, +8.99 (0.82%)
NYSE Composite 6,965.11, +63.20 (0.92%)

Advancing issues led decliners, as expected, by a healthy margin, 4992-1425. New highs exceeded new lows, 298-80. Volume was at almost the exact same level as that of the previous two sessions; not surprising, since these days it's just the same people moving the same stocks back and forth, to and fro.

NASDAQ Volume 2,263,999,250
NYSE Volume 5,161,690,500

Commodities markets were a bit more rational, with oil closing down 22 cents, at $78.98; gold losing $7.80, to $1,187.70; and silver dipping two cents, to $18.10.

With the indices all closing above their 200-day MAs, one might assume that the bulls are off and running once again, but I purport that it is only a temporary condition, based entirely on strong earnings reports (notwithstanding everything else, a very positive sign, but wholly in contraction with economic reality) which will come to a sudden end next week. This looks every bit like a temporary summer rally, which end as quickly as they begin.

Stocks Explode to Upside on Earnings

Well, apparently whatever it was that Ben Bernanke said on Wednesday to the Senate Committee, spooking the markets into an immediate and swift pullback, was not all that important because prior to the opening bell three Dow components - 3M (MMM), AT&T (T) and Caterpillar (CAT) - released second quarter earnings above expectations and sent stocks off to a roaring start.

The enthusiasm for equities was not in the least tempered by higher initial unemployment claims, which came in at 464,000, well ahead of last week's 427,000. So long as companies were turning sizable profits, nothing was holding back investors from buying.

Even existing home sales being down 5.1% for June or the Index of Leading Indicators dipping 0.2% had no effect on the rush to buy into the good news from corporate earnings.

Dow 10,322.30, +201.77 (1.99%)
NASDAQ 2,245.89, +58.56 (2.68%)
S&P 500 1,093.67, +24.08 (2.25%)
NYSE Composite 6,901.91, +170.75 (2.54%)

Advancing issues reversed Wednesday's drubbing, leading decliners, 5498-1017, and new highs soared ahead of new lows, 278-82. On a day which held such unbridled enthusiasm, there were more new highs (46) on the NASDAQ than new highs (39), reversing a three-day counter-trend. Volume was roughly at the same level as the previous session, though for bulls, it was a positive sign.

NASDAQ Volume 2,264,130,750
NYSE Volume 5,504,649,500

Oil futures were really the big winner on the day, with the September contract rising $2.74, to $79.30, the basis for which was unknown. Gold and silver were ahead only slightly, with gold gaining $3.90, to $1,195.50, and silver up 32 cents, to $18.12.

Every sector showed positive results as earnings season finally produced some results on which traders could trust with their money.

Despite the high quality of earnings, the major indices have yet to break through their 200-day moving averages, which are providing fairly stiff resistance, though corporate earnings continue to defy economic indicators.

At some point, possibly as early as tomorrow, stocks should break out from their recent range, tossing aside the cockeyed government reports and focusing on profits and valuations, like today.

Anecdotally, valuations may be as rich as they may get. For instance, 3M, which reported earnings of $1.54 for the most recent quarter, is trading at a multiple of 16.5 times trailing earnings, fairly rich.

AT&T is trading at 11.5 times earnings, while Caterpillar sports an ultra-rich multiple of 25.75 times earnings.

Traditionally, stocks trade in a range of 12-15 times earnings. Considering the headwinds into which companies are running, the low end of that range may be more appropriate at the present. That kind of metric is keeping a lid on stocks currently.