Recent Data Suggest More Fed, But Is That A Good Thing

As diva Pink so aptly put it, "Don't let me get me, I'm my own worst enemy, I'm a hazard to myself". A patient in excruciating pain will continue pumping morphine in his/her veins, left unchecked, until they go into cardiac arrest. Investors so to seem to only exhibit signs of relief when they get a Central Bank direct injection of capital. This can only go on for so long before these interventions are met with screams for more and more when in fact little is left to do.

The news from Europe is rarely palatable. The surge in yields on both Spain's and Italy's bonds is a reflection of the stresses in the system and reflective of the difficulties both face in attracting fresh capital. The problem for both countries are structural as well as severely over-leveraged balance sheets for both governments and financial institutions. First structural. Think Wisconsin where government and unions became far too cozy bedfellows. The agreement, hire more government workers with overly generous and ultimately unsustainable benefit packages and we'll guarantee our financial support and sizable voting block. Now back to Italy and Spain, they are Wisconsin squared. Once a person is hired there it is nearly impossible to fire them and in many cases companies wind up before a judge pleading to downsize to survive. Why oh why would any company add a new employee in this current uncertain economic environment? They wouldn't, won't and aren't. This is the dilemma Spain's President Rajoy and Italy's Prime Minister Monti inherited. PM Mario Monti is a change agent and is working towards liberalizing Italy's labor force. It won't be easy, the unions are powerful, embedded and reluctant to any give backs. President Rajoy is also facing the same battle while simultaneously Spain's banks are beginning the painful process of writing down or off the value of their real estate loans and holdings. Spain's real estate bubble mirrors Florida and Arizona. Now comes the pain our banks took in writing down the value of those impaired assets. This creates craters where their capital base used to be. Thus the need for the bailout of their banks currently requested amount of $125 billion.

The EU membership and Germany specifically have used a water pistol where they needed a fire hose to douse this raging inferno. They have come to the point Hank Paulson faced when he went before Congress, begged for and received his "bazooka". Had the Euro-zone come out forcefully when this fiasco began, it would have bankrupted the bond vigilantes and drawn a line in the sand that said sternly "NO MORE". Much akin to the Federal Reserves many acronym-ed programs, i.e., TALF, PPIP, etc., that re-liquefied our credit markets that had frozen up. With the recent announcement offering direct injections of capital into systemically important banks, the EU is now getting close to the point of having enough fire power to quell the contagion. The next step is potentially equally daunting and scary for them, fiscal unity and further integration. Change can be uncomfortable being the great unknown and all, but the Euro-zone cannot exist in currency alone. We're close and we are getting there, we're just taking Euro-steps, er, rather baby steps.

The US economic expansion has been uneven and lackluster at best. The first quarter GDP of 1.9 seems to be the crystal ball look at the future rather that the hoped for rear view mirror version or ghosts of Christmas past. Highlights:

Leading Economic Indicators: registered at +.3 for May supporting an ongoing economic expansion thesis for the next six months.

Industrial Production: slowed some but is still + 4.7 year/year.

Factory Orders: came in a much better than anticipated +.7 for May.

Auto Sales: as reported this past Tuesday came in at a better than anticipated 14 million + run rate.

Housing: continues to flash signs of rounding out a bottom. The NAHB Housing Index came in at 29, the best reading since 2007, suggesting much improved builder confidence. Further, building permits popped 7.9% pointing towards an important economic driver no longer being a drag to employment and may actually add to GDP growth figures.

Energy :Oil has corrected 20% pulling gasoline prices with them which should act like a tax break for consumers. This allows for more freedom with their discretionary monies which should continue to support retail sales as seen with auto sales and home improvements.

Fed Policy: remains highly accommodative with the funds rate firmly entrenched below .25%. Chairman Bernanke is fully aware of potential risks to the ongoing expansion and seems ready to do whatever is necessary to keep our economy afloat.

Global Central Banks: are back engaged in priming stalling economic growth engines with China, Brazil and India cutting interest rates most recently.

Low lights:

ISM Index: dipped below 50. A reading of 50 or above suggests an expanding economy. One reading does not a trend make though so we'll be watching this closely.

Weekly Unemployment Claims: seem to be in a bottoming formation here also. Should they stay in the current range, 355-390,000 no problem, should they begin trending higher and above 400,000 we could be in for some trouble.

Political: stalemate in Washington, until after the elections anyway.

Going Forward. Aside from the Federal Reserves Operation Twist, investors and consumers continue their own response to the current environment, Operation Squirm. Consumers and Investors are falling victim to fatigue. The constant barrage of negative news and threats from a messy Euro dissolution, China hard landing and/or our very own fiscal cliff leave investors and corporations hoarding cash. China has orchestrated the piercing of its property bubble and now begun easing rates to re-stimulate their domestic economy. The EU has finally taken steps towards a real union with recent announcements towards one both in name and currency. Oil, gasoline and commodities in general have corrected nicely in the second quarter which should provide some relief to input costs for corporations. The glut of natural gas and increased domestic oil production and natural gas liquids is aiding our slow stride towards energy independence while also creating thousands of jobs. The drop in natural gas prices coupled with renegotiated wages for union workers and a weaker dollar have companies repatriating jobs which were off shored over the last few decades along with actually upping domestic manufacturing of goods for export. The US becoming an export powerhouse yet again one day. Hmmph! Wasn't sure I'd be able to say that in my lifetime again. But, I stray. Foreign Central banks due to the spillover from the EU potentially re-entering area wide contractionary growth levels are once again fully engaged joining the Bank Of England, Bank of Japan and Federal Reserve.

Earnings estimates for the S&P 500 have been trimmed some due to the easing of global demand and the strength of the US dollar, but even so still hover at the $102-$106 range. In this current environment of low inflation, low interest rates and modest expansion attaching a 15 price/earnings (P/E) multiple gives us confidence of more upside improvement to the markets for the rest of the year.

So, for now we'll maintain our outlook and market friendly posture. However, should we become too reliant on the Federal Reserve and Foreign Central bank tonic (stimulus) for our markets life support, we'll be reaching for the defibrillator paddles and giving everyone the signal to CLEAR as we charge to a more defensive structure.

Thank you again for the opportunity to work with you in these very challenging times we live in.


Yours in pursuit of the KWAN!