So what did we see last week that I forecasted:
False rally - A hard charge up 400 points and a hard fall down 400 points, to end the week down 1% for the DOW and -2% for the NASDAQ.
Weak Economic News - Was there any positive news? Eventually, the tide had to break on the hard-news rocks. Bush says there won't be a recession, but that's sideline cheerleading when your team is fighting the good fight in a losing game.
So I seem to have a solid feel for the pulse of the market. What does that say about this week and what good is it going to do me if I don't make some major changes in the portfolio.
Let's start at the top: the coming week.
At first glance, the economic events coming up don't look too exciting. But I see a nugget on day one: Monday's Manufacturing Report. Right there is probably the most critical data of all. Everyone knows that the housing and financial sectors are in a depression. And the consumer sector is showing cracks - the weak ones, like Sharper Image, are falling back while the herd advances.
Manufacturing isn't just important as the potential last stand for economic growth (after agriculture), this is where we test the theory that exports are growing. Everything hinges on positive exports. Without it, the recession will be even deeper and faster.
That signal gets picked up Wednesday with the Factory Orders data.
We aren't looking for seismic changes or surprises. We just want the data to align with our investing thesis: that a cheap dollar is driving up exports and crushing imports. These two signals should be a confirmation. And if there's a flight to safety, it will be to the exporting sectors.
Which isn't to say that the market will surge one way or the other. Monday will be a response to Friday's sell-off. I'd like to see some bottom-feeding but it's more likely to be a continuation of the Friday fear and tentativeness.
Finally, the week will end with unemployment data, which should show a big jump. Right now there is mild belt tightening, but how often really does it stay moderate?
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Corporate response to a downturnInflation is jerking up in non-food, non-oil related sectors. We saw 4.3% annualized inflation, but ~8% for year over year. The biggest jump ever. Companies are charging more for goods and services.
Companies are passing on higher costs to consumers and several things are driving this development.
1)
The China deflationary effect has run its course. Costs have been completely wrung out of the manufacturing part of the food chain. Retail already got knocked around hard, thanks to the internet, and the advent of a just-in-time distribution network. Now only the input costs remain higher than they should.
2)
Retail Prices are lagging. I think the internet has been a certain check on corporate pricing strength. They can charge a reasonable margin but anything more and a competitor steps in fast. And there are contracts that delay the ability to raise costs. I also add in the fact that consumer spending was so strong the past few years that companies could absorb rising costs and still keep margins where they wanted them.
3)
Consumer spending is weakening. Companies can't maintain margins and growth if spending starts to drop. Throw in the higher costs and companies must move - so they are raising prices.
In addition to price hikes, expect to see more creative tricks like reducing volume. Shave 1 ounce off the 12 ounce size of soap. Big cereal box hiding a much smaller bag inside.
If this lasts - price hikes being passed on - we are officially in a Stagflation economy. I think a more likely trend is towards commodity price deflation. Strange to say that in the face of surging gold prices, wheat prices, steel prices, oil prices, and so on. But that's because most are peaking. And that's a very contrarian thing to say, btw, and I don't say it lightly.
Wheat, corn, soybeans, beef, etc - Not due to a rising dollar. Global production shortfalls and the stupid US ethanol craze (less land for soybeans makes them pricier, more demand for potash makes everyone pay more, etc).
Gold prices - I was wrong a few months back when I said that the dollar's descent would slow. And that's what is driving a lot of this ascent. Not all, but a lot.
Oil prices - Again, tied to a weak dollar and Chindia demand
(BTW I think the dollar will remain weak and get a little weaker even (hey, another rate cut is on the way). But not more than 15% from here. In any case, the downward trajectory will continue - so again we look to exports to grow.)
Against this inflationary background, companies are raising prices. Unfortunately, they are doing so just as the consumer is belt tightening. So corporate margins will not be holding up.
To cut prices, everyone will be squeezing their vendors. That leads to some interesting pressures that ultimately include layoffs. With manufacturing operating efficiently already, and input costs not likely to drop much anytime soon, there are only two places where savings exist: distribution and people.
People will be getting fired. Not mass layoffs yet, but a few stores will be closed or consolidated or however they want to spin it.
Are there any distribution savings? Actually yes. Consider KSU again. Walmart will import $9B from China in 2008. They will spend an additional $9B offloading that merchandise in Long Beach (LA). They could drop that to $2B shipping into Mexico's ports. Then Walmart ships to its distribution centers in the mid-west: that means more trucking and gas fees. Again, KSU is a cheaper alternative, shipping via train directly from Mexico's port to Kansas City.
Considering the cost savings for Made in Asia importers and considering the boomtimes in the Mid-West, KSU is uniquely positioned.
Some companies may even look to railways as a cheaper postal delivery option. Packages may take 6 days, not 3, but at a much lower price.
But overall the trend is inflationary.
Government spending is also under threat. The city of Vallejo threatened bankruptcy and thereby won a cut in the salaries of the police: from last year's approved 8.5% raise to just 2.5%. Yes, 8.5%. This type of self-rewarding mechanism is afflicting every municipality. Vallejo is not a small city either: population of ~120,000.
But it is testimony to the end of boom times. An 8.5% annual raise is boom time spending. Maybe real estate property boomtimes drove this behavior, but those days are long gone. And when a largish municipality threatens bankruptcy and the unions buckle, well, just imagine how eye-catching that is to other municipalities.
So less money will be flowing from City coffers, inflation is still strong, and the weak dollar makes all commodities expensive. And the wealth effect of diminishing home prices, falling stock markets and tighter credit, well, it isn't pretty. Belt tightening is here for a while.
The question is one of degree. Agriculture is booming, after all. And perhaps the manufacturing sector will kick in.
