GLOBAL DECOUPLING? THINK AGAIN MR. BERNANKE!

Ben Bernanke of the Federal Reserve has suggested that the US and other international markets may not have as much impact on each other as some might have thought – a phenomenon now titled ‘de-coupling’. This appears to have been part of the Fed’s rationale for not supporting the US dollar while decreasing domestic interest rates over the last year. Clearly it’s time for the Bernanke to think again. Larry Kudlow (CNBC, Prudential) has been looking for Bernanke’s ‘inner Volker’, a nod to Paul Volker (former Fed Chairman under Clinton) successfully battling inflation while strengthening the US dollar. While the Fed most easily supports the dollar with interest rate increases, there are other means at their disposal.

US Treasury Secretary, Hank Paulson, addressed members of the United Kingdom, European Union and the international financial press yesterday from Chatham House in London and did everything he could to say as little as possible, with as many words as possible, but still evidence the US’s commitment to a strengthened dollar. This was orchestrated to come one day in advance of the European Central Bank’s President Jean-Claude Trichet – our version of Ben Bernanke at the Federal Reserve – announcing a widely anticipated increase in the ECB’s key lending rate of .25%. The US markets experienced a broad sell off, oil climbed to record territory, gold regained some of its recently lost value and the US dollar took a beating after Paulson’s comments, but did so on extremely light volume – that’s the good news.

The concern is that if the ECB begins a series of rate hikes to thwart inflation in the EU, it will further undermine the strength of the dollar. Especially in light of the fact that the Federal Reserve isn’t likely to raise US interest rates until after the presidential election, even though some modest rate tightening would go a long way to support the Federal Reserve and Treasury’s efforts to strengthen the dollar. Fortunately, further tightening by the ECB now appears unlikely, and the Federal Reserve can rest more easily knowing that there is less pressure to tighten US rates and risk the possibility of affecting the outcome of the US presidential election. Today the US markets are responding positively to Trichet’s follow-up comments. "Starting from here, I have no bias [on interest rates]”, Trichet told reporters at his monthly news conference, suggesting that the ECB’s rate increase is not the start of a series of increases that would further weaken the dollar.

JOBLESS CLAIMS REMAIN STEADY AT 5.5%

Last Friday the markets responded very poorly to ADP’s jobs estimates of a reduction of some 80,000 US jobs for June. ADP, the nation’s largest payroll processing firm, is usually represents an accurate forecasting mechanism; this time they got it wrong by over 30%. The actual jobs number is now available and reports a loss of 62,000 jobs; the unemployment rate is holding steady at 5.5%. While this is terrible news for those looking for work and it accurately reflects an economic slow down, it’s actually better news that it sounds. We have lost some 500,000 jobs in our economy in the last 6 months (an annual rate of 1,000,000 jobs) while the last several US recessions have been met with jobs losses at an annual rate of over 2,000,000 jobs. Additionally, inflation is one of our greater long-term concerns and meaningful inflation can’t exist without substantial increases in personal incomes and those increases aren’t likely with unemployment hovering above 5%.

A CASE FOR THE NEXT REBOUND

Our economy consistently shows that there is more than enough capital available for aggressive investment and that money moves from sector to sector looking for values. Unfortunately, that often manifests itself in boom and bust cycles. This can easily be seen in the flow of funds into technology stocks that fueled the dot com bubble of the late 90’s. As money flowed out of that sector, it rested in the real estate markets and the venerable Alan Greenspan declared that there appeared to be ‘froth’ forming in that market. Froth, of course, is thousands of tiny bubbles – he was right. Money then flowed from real estate into oil, gold, and other commodities and that market is now showing signs of being played out, or surely will in the near future. Where will these aggressive investment dollars go next? Many think that the US stock market will be the recipient. The average P/E ratio of the stocks that make up the S&P 500 currently sits at less than 14 whereas the average P/E for those stocks usually runs in excess of 19. Valuations are now down in excess of 20%, and the market is evidencing that it is clearly oversold. Will a US stock market rebound come in advance of the presidential election? Possibly so; not very likely; but that it will come is inevitable.