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Last week there was quite a bit of negative news on inflation, manufacturing, and housing. While part of the weakness in the economy was greater than expected, the big factors weighing on equities were gloomy reports coming out of the financial sector and continued elevated oil prices.
Equities fell sharply last week – especially the blue chips. Key factors were lack of progress in getting oil prices down, losses in the financial sector, and a warning of a downgrade by Standard & Poor’s.
Monday was mixed as blue chips were little changed while techs and small caps posted notable gains. Financials actually got a boost at the start of the week as Lehman Brothers’ losses were no worse than expected. Techs rallied after a positive review by an analyst of the new iPhone’s likely impact on Apple’s profits and after oil retreated from intraday trading near $140 per barrel. Most stocks fell on Tuesday on stagflation concerns after a strong headline PPI number and negative reports on industrial production and housing starts. Financials were mixed for the day as Goldman Sachs beat expectations with losses less than expected, but concerns about the sector pulled down American Express, Bank of America, Merrill Lynch, Morgan Stanley, and some regional banks.
Stocks fell on Wednesday on an upward reversal of oil prices. Stocks were particularly volatile as many investors were unwinding positions ahead of Friday’s quadruple witching. A fuel-related loss for the latest quarter at FedEx also weighed on the markets as the shipping firm is seen as a bellwether for the economy. Half-size profits at Morgan Stanley pulled financials down as did Fifth Third’s sharp cut in dividends. Stock rebounded on Friday, largely due to a $5 slump in oil prices after China announced a hike in fuel prices based on reduced subsidies. But equities sold off sharply on Friday on several factors. Financials fell on reported drops in profits by Morgan Stanley and Goldman Sachs. Also pushing down equities were financial sector downgrades to Ambac, MBIA and some regional banks, a surge in oil prices, and to a lesser degree, quadruple witching. The final factor bringing stocks down was a late afternoon warning by Standard & Poor’s of possible downgrades to credit ratings for GM, Ford, and Chrysler.
Last week, major indexes were down as follows: the Dow, down 3.8 percent; the S&P 500, down 3.1 percent; the Nasdaq, down 2.0 percent; and the Russell 2000, down 1.1 percent.
For the year-to-date, major indexes are down from year end as follows: the Dow, down 10.7 percent; the S&P 500, down 10.2 percent; the Nasdaq, down 9.3 percent; and the Russell 2000, down 5.3 percent.
Weekly percent change column reflects percent changes for all components except interest rates. Interest rate changes are reflected in simple differences.
 Treasury rates eased somewhat last week despite higher inflation fears as flight to quality over credit market concerns fueled a mild rally in Treasury prices.
Rates were little changed on Monday ahead of Tuesday’s reports on key economic indicators. Treasury yields eased on Tuesday despite a spike in headline producer price inflation as declines in housing starts and industrial production led many traders to back away from the belief that the Fed might be tightening late this year. Rates eased further on Wednesday on bad news from key investment firms and from FedEx which suggested that the economic slump will continue longer than expected. But on Thursday a spike in the Philly Fed’s prices paid index raised concern that the Fed might raise rates late in the year after all. But yields slipped on the last day of the week on flight to safety as equities declined sharply and on news of downgrades to bond insurers Ambac and MBIA.
 On the week Treasury rates were down moderately as follows: 3-month T-bill, down 12 basis points, the 2-year note, down 16 basis points; the 5-year note, down 15 basis points; the 10-year bond, down 10 basis points; and the 30-year bond, down 7 basis points.
Despite mild slippage in rates last week, Treasury yields remain near their recent highs due to continued inflation concerns.
 Once again, there were sharp swings in oil prices during the week but spot prices for West Texas Intermediate ended the week down by just pennies. Nonetheless, the sharp swing back up at the end of the week weighed heavily on equities.
Monday started the week’s wild ride as intra-day trading hit a new record high just under $140 per barrel but slid over $6 per barrel to end the day down and at $133.96 due to profit taking. After little change on Tuesday, prices jumped over $2 per barrel on a drop in U.S. inventories and on news that Nigerian oil workers are threatening to strike. But the biggest move of the week was Thursday’s nearly $4 per barrel drop to $132.18 per barrel after an announcement by China that it would be raising gasoline and diesel prices which will reduce demand. But prices turned back up on Friday after reports that Israel had conducted military exercises earlier in the month that might be related to a potential attack on Iranian nuclear facilities. Concern over a labor strike by Nigerian oil workers also lifted prices.
Net for the week, spot prices for West Texas Intermediate slipped only 23 cents per barrel to settle at $134.62 per barrel – down $3.92 from the record settle of $138.54 set on June 6.
This past week, economic data pointed to further declines in housing and in manufacturing as inflation heated up at the headline level.
 The upward blip in starts in April appears to have just been temporary as starts in May fell 3.3 percent, following the 2.0 percent rebound the prior month. The May pace of 0.975 million units annualized was down 32.1 percent year-on-year. Not surprisingly, the May decline was led by an 8.0 percent drop in multifamily starts as single-family starts fell another 1.0 percent. April’s rise had been led by a jump in multifamily starts. Permits also decreased in May -- by 1.3 percent, following a 5.4 percent pick up in April. May's 0.969 million unit pace for permits was down 36.3 percent year-on-year.
By region, the decline in starts was led by a monthly 25.0 percent drop in the Midwest with the West and South also showing decreases of 10.3 percent and 4.4 percent, respectively. In the Northeast, starts rebounded 61.5 percent.
Of course, the weakness in housing has spread to other sectors which depend on housing growth. Retail sales of furniture & home furnishing typically slump along with starts and the latest downturn is not an exception. Retail sales at furniture & home furnishing stores were down 5.1 percent on a year-ago basis in May.
 Industrial production was weaker than expected in May but weakness was led by a drop in utilities output. Nonetheless, the bottom line still is that the manufacturing sector is flat. Overall industrial production fell 0.2 percent in May, pulled down by a 1.8 percent decline in utilities output. Still, the important manufacturing component was flat, after falling 0.9 percent in April. Manufacturing actually was supported by a 1.0 percent partial rebound in production of motor vehicles as striking workers returned. But the impact on overall manufacturing was slight. Manufacturing excluding motor vehicles slipped 0.1 percent after dropping 0.5 percent in April.
Within manufacturing, both durables and nondurables were unchanged for May. On a year-on-year basis, industrial production in May eased to down 0.1 percent from up 0.1 percent in April.
Overall capacity utilization in May slipped to 79.4 percent from 79.6 percent the prior month and compared to the market forecast for 79.7 percent.
 More recent news on the manufacturing sector is not getting better and, in fact, is somewhat worse. Both the Philly Fed and New York Fed manufacturing surveys showed contraction for manufacturing in June.
The Philly Fed’s business activity index fell another point-and-a-half into negative territory, to minus 17.1 from minus 15.6 in May. The same report found new orders, shipments, and employment indexes also contracting.
The New York Fed’s Empire State manufacturing index also worsened in the latest month – falling to minus 8.7 from minus 3.2 in May. New and unfilled orders indexes were negative.
Both surveys showed extremely elevated prices paid indexes. For the Philly report, prices paid jumped more than 15 points to 69.3, while prices received remains unusually high at 29.7 though a bit less severe than May's 31.6.  The prices received index for the Empire State report spiked more than 11 points in June to a 26.5 level that is highly elevated for this report. Prices paid were roughly steady at 65.1. The bottom line from these reports is that manufacturing is stagnant while inflation pressures are building.
 Producer price inflation in May surged at the headline level while the core rate remained moderate. The overall PPI jumped a red hot 1.4 percent, following a modest 0.2 percent rise in April. However, the core PPI rate grew a more moderate 0.2 percent, following a 0.4 percent boost in April. The headline number was led by a 4.9 percent hike in energy prices while food also rose a strong 0.8 percent.
Producer price inflation at the headline level is starting to look like a return to the 1970s. For the overall PPI, the year-on-year rate jumped to up 7.2 percent, compared to 6.4 percent in April (seasonally adjusted). The core rate was unchanged at up 3.0 percent.
While the core rate has been relatively well behaved compared to the headline number, the core’s year-ago pace nonetheless is at its highest since a 3.1 percent pace for December 1991. Also, the core rate is rising at earlier stages of production, surging to a 6.8 percent pace at the crude level and rising to 1.5 percent at the intermediate level. Both are up significantly from two years ago.
The economy more and more appears headed for stagflation. Forecasts for economic growth later this year have been downgraded and the latest housing and manufacturing numbers support those views. Headline inflation continues to heat up and Fed officials have to be worried that it may start seeping into core inflation.
The week ahead has a number of high profile market moving indicators, with the highlight likely being the FOMC statement on Wednesday. The durables orders report will give us an update on manufacturing and the personal income report will have key insights into the health of the consumer sector. We will get the last revision to first quarter GDP on Thursday – not counting annual revisions. Also, we get news on the housing sector with both new and existing home sales reports.
The Conference Board's consumer confidence index remains at dismal levels and even continues downward with the main index falling nearly 5 points in May to 57.2, the lowest reading since 1992. But more importantly, 12-month inflation expectations swelled to 7.7 percent, up 9 tenths from May. The consumer confidence report appears to be pointing to the increased likelihood of moderate stagflation.
Consumer confidence Consensus Forecast for June 08: 56.5
Range: 51.0 to 63.3
Durable goods orders have been unexpectedly strong except in transportation as April orders slipped 0.6 percent in April, following a 0.2 percent decline in March. However, excluding the transportation component, new orders advanced a strong 2.4 percent in April, following a 1.8 percent gain the prior month. The rebound was primarily in electrical equipment but other industries also showed gains. Weakness was led by a 7.9 percent fall in transportation, which included a sharp drop in nondefense aircraft. Motor vehicles and defense aircraft also declined. Levels for overall durables are still soft after notable declines in the first quarter.
New orders for durable goods Consensus Forecast for May 08: 0.0 percent
Range: -2.2 percent to +1.0 percent
New home sales improved in April, rising 3.3 percent but against a downwardly revised March level. March's 509,000 annualized pace is the lowest since just after the end of the 1990-91 recession with April’s 526,000 pace the second lowest. April’s year-on-year percentage decline of 42.0 percent is the worst since the early 1980s. Prices steadied in the month, jumping 9.1 percent to a median $246,100 for an actual year-on-year increase of 1.5 percent and the best level since November. But the price increase is likely due to a shift in sales away from the low end due to tighter credit restrictions. Supply remains heavy at 10.6 months vs. 11.1 months in March.
New home sales Consensus Forecast for May 08: 515 thousand-unit annual rate
Range: 500 thousand to 570 thousand-unit annual rate
The FOMC announcement for the June 25 policy meeting is expected to leave rates unchanged at 2.00 percent for the fed funds target rate and at 2.25 percent for the discount rate. The previous FOMC statement and latest minutes indicated that risks were balanced between too low growth and too high inflation. Additionally, Fed officials have repeatedly stated in speeches that fighting inflation is now the higher priority. There likely will be no surprise on interest rates but markets will be parsing the wording of the FOMC statement for any indication on how soon the Fed may or may not be raising interest rates.
FOMC Consensus Forecast for 6/25/08 policy vote on fed funds target: unchanged at 2.00 percent
Range: 90 percent probability for no change based on fed funds futures June 20, versus 10 percent probability for 25 basis point increase
GDP growth for the first quarter was revised up to an annualized 0.9 percent, compared to the initial first quarter estimate of 0.6 percent. The upward revision to the percent change in real GDP primarily reflected a downward revision to imports and upward revisions to nonresidential structures and to PCEs for nondurable goods that were partly offset by downward revisions to private inventory investment, to exports, and to PCE for services. On the inflation front, the first quarter GDP price index was unrevised at an annualized 2.6 percent, following the fourth quarter's 2.4 percent.
Real GDP Consensus Forecast for final Q1 08: +1.0 percent annual rate
Range: +0.9 to +1.2 percent annual rate
GDP price index Consensus Forecast for final Q1 08: +2.6 percent annual rate
Range: +2.6 to +2.6 percent annual rate
Initial jobless claims declined 5,000 in the week ending June 14 to 381,000. The four-week average rose 3,250 to 375,250, slightly higher than at the same time last month. Continuing claims for the April 19 week fell 76,000 but were still above 3 million at 3.06 million. Overall, the labor market remains soft.
Jobless Claims Consensus Forecast for 6/21/08: 380,000
Range: 375,000 to 386,000
Existing home sales fell another 1.0 percent in April to an annualized pace of 4.890 million units, matching January as the lowest in nine years of available data. Supply on the market ballooned further, rising to 11.2 months from 10.0 months in March for the worst reading since 1985. The median sales price rose 1.1 percent from March to $202,300 but was still down 8.0 percent from a year ago.
Existing home sales Consensus Forecast for May 08: 5.00 million-unit rate
Range: 4.84 to 5.15 million-unit rate
Personal income growth appears to be softening as April’s increase eased to 0.2 percent, following a 0.4 percent advance in March. April’s true weakness was masked by income tax rebate checks as the wages and salaries component actually fell 0.2 percent, following a 0.5 percent boost the month before. A surge in government benefits reflected the start of the income tax rebates intended to boost the economy. On the spending side, personal consumption rose 0.2 in April after jumping 0.4 percent in March. On the inflation front, the headline PCE price index came in with a 0.2 percent increase, following a 0.3 percent gain in March. Meanwhile, the core PCE price index slowed to 0.1 percent in April, following a 0.2 percent increase the prior month. With the latest jump in the overall CPI to 0.6 percent for May, we are likely to see a similar increase in the headline PCE price index.
Personal income Consensus Forecast for May 08: +0.4 percent
Range: +0.2 to +1.9 percent
Personal consumption expenditures Consensus Forecast for May 08: +0.7 percent
Range: +0.3 to +0.9 percent
Core PCE price index Consensus Forecast for May 08: +0.2 percent
Range: +0.2 to +0.2 percent
The Reuter's/University of Michigan's Consumer sentiment index sank further to 56.7 for the mid-June reading from 59.8 in May. June’s figure is the lowest on record since the series began in 1952. The second lowest reading was 57.6 for February 1975. For the latest month, one-year inflation expectations slipped 1 tenth but remained high at 5.1 percent while 5-year expectations were unchanged at 3.4 percent.
Consumer sentiment Consensus Forecast for final June 08: 56.9
Range: 55.9 to 58.0
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