Weekly Marketmail

Market Ignores a New Wave of Bad News, Rising 2.4%
By Louis Navellier

Last week, the market performed amazingly well, as it continued to rebound from an extremely oversold condition just two weeks ago. The market turned in its second straight 2+% gain last week, bringing the averages back into positive ground for 2010. Maybe the market was glad to see that the Bears finally made the cover of BusinessWeek last week. That’s a great contrary indicator and an historic “buy” signal.

Yesterday’s Biggest Fears Came True: So What?

The market took some pretty terrible news in stride last week. Some of our worst fears happened, but the market didn’t seem to care. For instance, the New York Stock Exchange (NYSE) announced Wednesday that both Fannie Mae and Freddie Mac will be delisted. Freddie Mac said that it expects its shares to trade on the lowly OTC bulletin board after its NYSE delisting, which could happen as soon as July 8.

Fannie and Freddie were two of the best-performing stocks in last year’s powerful market surge, mostly due to two violent short-covering rallies that began on March 10 and August 3, 2009. Fannie and Freddie were “poster kids” for the Year of the Junk Stock, when so many bad (money-losing) stocks led the rally.

As Freddie, Fannie and other low-quality stocks “flame out,” the quality stocks are leading the current recovery, giving us an important leadership shift, as we see the market return to positive territory in 2010:

Market Index:

Dow Jones Industrials: Last Week: +2.35% Year-to-date +0.22%
S&P 500: Last Week: +2.37%, Year-to-date +0.22%
NASDAQ: Last Week: +2.95%, Year-to-date +0.79%

Last week, a lot of other bad news reached a boiling point, but the market still behaved well. In addition to the grilling of BP CEO Tony Hayward and the delisting of Fannie and Freddie, Greece’s government bonds were downgraded by Moody’s from A3 to Ba1 (i.e., junk status), but the stock market didn’t seem to care. The same was true for Spain. The Financial Times reported that Spanish banks borrowed $105 billion from the European Central Bank in May – their highest-ever cash infusion – yet the euro rallied!

Far from seeing nations like Greece banned from the euro-zone, the euro’s orbit is actually growing. On Thursday, Estonia joined the euro-zone, even though the ECB warned that “maintaining low inflation in Estonia will be very challenging.” Simon Tilford, chief economist for the Center for European Reform, a research organization based in London, said “joining the euro is a status issue for countries seeking to cement their position at Europe’s top table.” Estonia will officially join the euro-zone January 1, 2011.

As the Euro Rallies, All Eyes Return to the U.S.

With Europe’s austerity measures giving the euro-zone a new rallying cry, the U.S. seems to be moving in the opposite direction. Instead of implementing austerity cuts and trying to get the federal budget deficit under control, President Obama is now trying to get Congress to approve a new $50 billion emergency supplemental spending bill for extending unemployment benefits, plus aid to save 84,000 state and local jobs. In the original $787 billion spending/stimulus bill, the federal government agreed to pay the first-year salary of new police hires and other public servants. However, now some of these new hires now face potential layoffs without supplemental federal funding due to financial shortages in many states and municipalities. All of a sudden, Europe looks better than the U.S. at austerity cuts and fiscal discipline.

While Congress was grilling BP’s CEO, former Fed Chairman Alan Greenspan was grilling Congress, in print. In a scathing opinion piece in The Wall Street Journal (titled “U.S. Debt and the Greece Analogy”), Mr. Greenspan said that the U.S. may soon reach the limit of its borrowing capacity and face higher costs on our debts. The former Fed Chairman called for a “tectonic shift” in fiscal policy to contain borrowing. “Incremental change will not be adequate” he said, since “the federal government is currently saddled with commitments for the next three decades that it will be unable to meet in real terms,” saying that the “very severity of the pending crisis and growing analogies to Greece set the stage for a serious response.”

The former Fed Chairman concluded by saying “Our economy cannot afford a major mistake in underestimating the corrosive momentum of this fiscal crisis” and stressed that “our policy focus must therefore err significantly on the side of restraint.” Greenspan also implied that the recent rally in Treasury securities (as money fled the euro) was “temporary,” which implied that last week’s sudden weakness in the U.S. dollar may persist and, with it, the U.S. government’s fiscal problems will rise.

In other Fed news, the FOMC will meet this Tuesday and Wednesday, with no interest-rate change expected, but the big surprise is that Fed Vice Chairman Donald Kohn will postpone his retirement (which was supposed to start Wednesday, June 23) due to a request by Fed Chairman Ben Bernanke. Kohn said he would retire no later than September 1, but the reason behind Bernanke’s request is causing some speculation, since it effectively helps to postpone the Senate confirmation hearings of President Obama’s three new Fed nominees. If these nominations can be postponed until after the mid-term elections, then it is possible that only one of these three “doves” that President Obama nominated may actually be confirmed by the Senate. Right now the only safe confirmation is the newly-designated Vice Chairman, San Francisco Fed President Janet Yellen, who is the most widely respected Fed “dove.”

Stat of the Week: Leading Indicators Up 0.4%

The U.S. economic recovery is growing slowly but consistently. Despite ongoing economic insecurities, such as slowing retail sales, mixed housing news and persistent unemployment problems, the Leading Economic Indicators (LEI) rose 0.4% in May. In addition, the Fed announced on Wednesday that U.S. Industrial Production rose 1.2% in May, following a 0.7% gain in April. The May rise was the largest gain since August, when production was boosted by the “cash for clunkers” program. Industrial output has risen 7.6% in the past year and capacity utilization is at 74.7%, the highest rate since October 2008.

Also, the Fed caught a break last week when the wholesale and consumer inflation statistics for May did not raise any new deflation fears, since the “core rate” (excluding food and energy) for the Producer Price Index (PPI) and Consumer Price Index (CPI) rose 0.2% and 0.1%, respectively. But when you add in a 1.5% decline in energy prices and a 0.6% decline in food prices, overall wholesale prices fell 0.3% in May. The CPI declined by a little less (0.2% in May), due to firming apartment rental and hotel prices.

Since the federal government is still spending up a storm, the U.S. dollar has fallen again, but the stock market loves a weaker U.S. dollar. The fact that the S&P 500 rose above its 200-day moving average last week is a positive sign. Now that the U.S. dollar’s rally appears to be over, commodities like gold and oil have resumed rising. Gold’s rise provides further confirmation that we have dodged the “deflation bullet.”

The other economic news remains mixed. On Wednesday, the Commerce Department announced that May housing starts dropped 10% after the expiration of the federal government’s tax-credit for new homebuyers. This raised fears of a “double dip” in the housing market. Building permits also dropped 5.9% in May after a 10.9% decline in April, but fewer new houses implies a recovery in real estate prices. This week, we’ll learn about May existing home sales (on Tuesday) and new home sales (Wednesday).

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