By Hal Eddins, Managing Director Capital Investment Council
Inflation, it seems, is everywhere. Consumers appear to be numb to $3 a gallon gasoline, but recent increases in food prices seem to be hitting home. On a personal note, one of my favorite restaurants has raised prices 7.3% in the last month alone. An excellent source on the food spending habits of consumers is the large discount retailers like Costco and BJ’s. Both companies are still seeing an increase in sales; in fact, Costco’s revenues were up 12% which is impressive in this tough environment. However, both BJ’s and Costco reported on recent conference calls that consumers are trading down in their protein choices. The high end beef buyer is moving down in price and prestige to chicken or even ground beef. The common wisdom is that people in the developing countries are beginning to eat in a similar manner to the established Western economies. The increased demand could continue to cause a sharp rise in food prices. This view could prove incorrect. China's meat consumption is already on par with the developed world and has been since 2005, so further increases in consumption may prove slow in coming. Bio fuels could be the real villain of the inflation story. Many resources traditionally devoted to growing crops have been diverted to the growth of bio fuels like ethanol. The long term viability of these biofuels could prove murky at best and consumers are left with inflation on both gasoline and food prices. Sometimes, well- intentioned plans do more harm than good.
Another question on the commodity front is how long this rally can last. Gold is tickling $1000 an ounce and oil is firmly above $100. It might be possible that our tough stock market environment is fueling the rise. Investors are desperate to be in areas that are still performing well and commodities are one of the few left. A potential problem might be that as the world economies slow down, the demand for items such as oil and copper will drop as well. The Baltic Dry Index measures shipping prices for all manner of dry goods. The Baltic Dry Index has been hit in recent months and two factors appear to be behind the drop. First, an increase in the number of ships available for transport: when supply outstrips demand, prices drop and second, a general drop in the demand for transport as many developing economies begin to falter. Many of the developing nations, Brazil in particular, are heavily dependent of commodity prices. Any hiccup in prices, could see a drop in those country’s stock markets.
One final note on commodities: let’s look back over the past twenty years. This will come as a surprise to many, but oil has underperformed global equities over this time frame. Additionally, oil has also suffered much higher volatility over that twenty year period. Some may argue that twenty years is not a long enough time frame. To get a longer view, let’s look back to the turn of the century: the 20th century that is. Going back to 1900, one still sees oil underperforming global equities and the volatility is higher by a ratio of 2 to 1. (Financial Times March 4 2008 p. 28) One could argue that it’s different this time but “it” usually never is. One potential reason for the continued upward pressure on oil prices is the growth in China. That fact is no big surprise, but the fact that's China's economy is four times as energy intensive might come as a shock. In the end, China's oil demand will likely continue to grow, but as the Chinese economy matures, their oil efficiency should improve and that could possibly see overall Chinese oil demand drop. Either way, it should prove interesting to watch.
US stores reported their February sales numbers a few weeks back. I see trends that indicate the consumer “trading down”. Wal Mart, with their large array of discount merchandise, appears to continue to be a beneficiary of this trend. A common misconception is that “the rich” always keep spending-even during a recession. This is increasingly not the case. Two of the largest US luxury retailers, Neiman Marcus and Saks reported drops in their February sales. The twist to these sales numbers was not the slow down of “aspirational” shoppers. These aspirational shoppers are usually “trading up” to a more expensive item such as a $2000 Chanel handbag. The surprise came in the drop in the core luxury segment. It appears that the truly wealthy buyer is feeling the pinch as well.
Clothes make the man? Well, they do in some countries. It’s always interesting to see how values change from culture to culture. A recent study shows that only 16% of US males attempt to show their virility (their term not mine) with their clothes. That number increases when you cross the Atlantic where 26% of European men use their outerwear to show “what they are made of”. While 26% is high, it pales in comparison with the 35% of Japanese males that assert their dominance with their pants or shirt. Think about that next time you are abroad.
On a lighter note, ESPN reported that 3,178,774 NCAA tournament brackets were filled out on their website. Only 4,621 brackets correctly included Villanova, Davidson, and Western Kentucky in the “sweet 16”. Finally, out of 3,178,774 brackets, only two brackets had all 16 correct choices. On a percentage basis that is .000001% of all brackets filed! Of course the choice that really matters is the champion. Given the way they are playing, there can be only one logical choice: the 2008 UNC Tar Heels.
The magic number for the end of March is 1330. This closing target for the S&P 500 would mean that the market would have a positive monthly close for the first time in five months. If the S&P 500 can achieve a positive monthly close, a possible near term target for the S&P would be 1400. 1400 is also important in the minds of many technically oriented managers: this level would be roughly a retracement of 50% of the decline on the S&P from last fall’s high to January’s low. Potential positive money flows from pension and mutual funds could stabilize the market into the important first quarter earnings reports in mid April.
The Dow’s rally of March 11th was the largest in five years. After the previous week’s decline, the rally was welcome indeed. The decline we saw on March 6 was a 90% down day. A 90% down day is defined where volume and points-lost are greater than 90%. Suffice it to say, we don’t see many 90% Down Days, and they are sometimes used as a contrarian indicator that a turning point may be at hand. To illustrate just how tough the 2008 stock market has been, Thursday’s drop was the 2nd 90% Down Day of the week and the 7th one since January!
As of Monday, March 10, the leading S&P stock sector was materials and they still showed a loss of (5.4%). On top of that, out of the S&P’s 129 industry groups, 118 were down as of March 10. The point here is that while the stock market may be a tough place to make money at the moment, the large declines coupled with the spike in fear and volatility may mean that the bad economic news is being priced in. We continue to buy positions in the best companies at valuations we have not seen in years. Remember that you can not be paralyzed by fear and yet still profit from it. This could be a wonderful time to reallocate your portfolios into higher quality companies that are currently very reasonably priced.
Disclosures:
Past performance is not indicative of future results. This material is not financial advice or an offer to sell any product. The actual characteristics with respect to any particular client account will vary based on a number of factors including but not limited to: (i) the size of the account; (ii) investment restrictions applicable to the account, if any; and (iii) market exigencies at the time of investment. Capital Investment Counsel reserves the right to modify its current investment strategies and techniques based on changing market dynamics or client needs. The information provided in this report should not be considered a recommendation to purchase or sell any particular security. There is no assurance that any securities discussed herein will remain in an account's portfolio at the time you receive this report or that securities sold have not been repurchased. The securities discussed may not represent an account's entire portfolio and in the aggregate may represent only a small percentage of an account's portfolio holdings. It should not be assumed that any of the securities transactions, holdings or sectors discussed were or will prove to be profitable, or that the investment recommendations or decisions we make in the future will be profitable or will equal the investment performance of the securities discussed herein. All recommendations within preceding 12 months or applicable period are available upon request.
Capital Investment Counsel is a registered investment advisor. More information about the about the advisor including its investment strategies and objectives can be obtained by visiting www.capital-invest.com.
