Dollar Weakens on Deflation, Deficits & Double-Dip Fears
By Louis Navellier
Despite last week's wide market swings and daily news jolts (like Apple's iPhone-4 antenna and the Gulf oil cap), the most important news last week may be the sudden drop in the U.S. dollar, based on deflation returning, deficits rising and fears that the U.S. economic slowdown might be worse than initially feared.
The euro has leaped from $1.22 to $1.30 since July 1, despite recent credit downgrades in Portugal and Ireland. While a declining dollar is discouraging, a weak dollar also helps boost U.S. exports and creates a currency tailwind for U.S. investors in foreign stocks and U.S. companies doing a major portion of their business overseas. In this report, I'll cover the "bad" news first, followed by some solid reasons for hope.
Fed Fears a New Deflation Threat
Last week's economic fears were exacerbated by the release of the latest Federal Open Market Committee (FOMC) minutes, in which it became very clear that the FOMC members were divided over the economic slowdown and the deflation risks to the U.S. economy. Officially, the Fed lowered its 2010 GDP forecast to a range of 3.0% to 3.5%, down from its previous forecast of 3.2% to 3.7%, but the FOMC deflation debate was the most disturbing news, due to the release of America's two major price indexes last week.
The Labor Department announced on Thursday and Friday that June's Producer Price Index (PPI) and Consumer Price Index (CPI) fell 0.5% and 0.1%, respectively. Although lower food and energy prices are largely responsible, the CPI has now fallen three months in a row, making some FOMC member nervous.
However, the June core rates (excluding food and energy) actually rose 0.2% (for the CPI) and declined by just 0.1% (for the PPI). In addition, during the first half of July, the U.S. dollar has been on a slippery slope, which tends to increase food and energy prices. (July prices won't be reported until mid-August.)
Another reason the U.S. dollar was on a slippery slope last week is that the U.S. economy seems to be slowing down and even turning negative in some key indicators. On Tuesday, the Commerce Department announced that retail sales declined 0.5% in June, worse than the 0.1% decline economists anticipated. Inventories also contracted by 1.5%, due to the fact that businesses are cautious. Contracting inventories can dramatically reduce economists' GDP estimates, which is bad news for second-quarter GDP growth.
On Thursday the Fed announced that U.S. industrial output rose only 0.1% in June, and this rise was due largely to the recent heat wave, yielding a 2.7% rise in utility output. But manufacturing declined 0.4%.
On Friday, we got the week's most shocking news when the University of Michigan/Reuters consumer sentiment index for July fell nearly 10 points, from 76.0 to 66.5, well below economists' consensus estimate of 74, reaching its lowest level since August. Also, the "expectations index" dropped to 60.6 in July from 69.8 in June, so future consumer spending, which represents 70% of GDP, remains uncertain.
Despite all the gloom and doom, however, the 55 economists surveyed by The Wall Street Journal are more optimistic about the direction of the economy than the general public: 64% of these 55 economists said that the economy will get better over the next year, while only 9% said it would get worse.
Stat of the Week: China Growth "Slows" to 10.3%
As the U.S. economy decelerates, China is increasingly becoming the primary economic engine driving the worldwide economy. China's second-quarter GDP grew at a 10.3% annual pace, down slightly from an 11.9% pace in the first quarter and reflecting a "soft landing" as Chinese inflation starts to moderate.
Another piece of good news is that China's inflationary housing bubble has stopped expanding, while Chinese exports are still booming. As a result of China's export growth, the U.S. trade gap with China expanded to $22.3 billion in May, the highest level since last October and a 15% gain over April's trade deficit level. This trend could put downward pressure on U.S. GDP growth. Since the U.S. trade deficit subtracted 0.8% from first-quarter GDP growth, May's deficit increase could hurt second-quarter GDP.
China's exports have now surged 44% in the past 12 months. This trend is not showing any signs of slowing down. In fact, due to a Chinese labor shortage, wages are now rising, which will help boost China's domestic consumption. China's retail sales rose 18.3% in June ("down" from 18.7% in May), while its industrial production rose 13.7%, down from 16.5% in May. This means China's "soft landing" is comparable to a NASCAR race driver slowing from 200 miles per hour (mph) to only about 185 mph.
You might be surprised to hear that a land of 1.3 billion people has a "labor shortage," but China's one-child policy has limited the number of new young skilled workers entering the Chinese labor force. Demographers say that Chinese workers in the 16-to-24 age bracket will fall by 33% in the next 12 years. Some factories are operating at 15% to 20% under labor capacity, forcing some bosses to bribe new workers with promises of more time off and higher pay - trends which will boost domestic consumption.
Bottom line, a strong China (reflecting a strong Asia and Latin America) will boost overall global growth, while a weak U.S. dollar helps U.S. manufacturing, exports and corporate earnings for multi-national U.S. companies. 2010 is already shaping up to be a great year for worldwide economic growth, thanks to a growing middle class in many emerging markets. As a result, investors are increasingly finding that the safest way to prosper from strong growth in emerging markets is to buy strong multi-national companies.
Three Favorable Seasonal Cycles Start Soon
We are now entering a time of favorable seasonal cycles. The first is quarterly: The beginning of second-quarter earnings season. So far, the corporate news is very good, with better-than-expected earnings. We are clearly in an environment in which the "smart" money is chasing the best stocks. We will keep our eye on those stocks that sustain strong earnings momentum as the overall stock market earnings growth rate decelerates, due to more difficult year-over-year comparisons and moderating economic growth.
The second cycle is economic. About 12-18 months after previous recessions officially ended, nervous businesses finally start hiring. Wall Street has very low expectations for job creation but private sector job creation has steadily improved in the past two months. The private sector created 83,000 jobs in June, up from a revised 33,000 in May. And last Wednesday, the Labor Department reported that first time jobless claims fell by a better-than-expected 29,000 to 429,000 in the previous week - a welcome turnaround.
The third cycle is political. The Presidential Cycle is the most influential and predictable cycle that affects the stock market. Historically, Wall Street starts celebrating Congressional "gridlock" even before the mid-term elections, starting around September. The stock market has historically rallied strongly from late September in the mid-term election year until the next Presidential election. If history repeats, we may see a 26-month rally starting soon. (Of course, we may see a summer swoon before that rally starts.)
In summary, we remain bullish due to global growth and a cyclical U.S. market recovery propelled by (1) a strong earnings announcement season, (2) gradually improving private (vs. government) job creation and (3) the impending mid-term elections, launching a 26-month rally until the next Presidential election.