Issue 45 - July 2, 2008


Black Gold

After posting solid gains in April and May, equity markets ended the quarter on a down note. Headline concerns over housing were replaced by the eye popping 35% quarterly gain in oil prices. Whether these gains are driven by real demand for the physical commodity or the unregulated demand of financial investors for a “non correlated asset”, it is safe to say that there is a tremendous amount of money headed in the direction of oil. There is a saying that “money goes where it is treated best” and for the immediate moment that is oil. However, just as we have seen through time, whether it be with tulips, technology stocks, or real estate, bubbles go on longer than we think possible and they work brilliantly until they burst. Dynamics are clearly underway to slow the global economy and with that it is hard to see a world wide demand profile that is consistent with today’s oil price action.

The Federal Reserve, The Banks, & The Earnings (The Good, The Bad, & The Ugly)

The Federal Reserve concluded their easing operations in April by lowering their benchmark rate to 2%. The combination of 325 basis points of easing along with the creative lending facilities available to banks and broker dealers alleviated the liquidly crisis that plagued the first quarter of 2008. However, the premium that lenders are currently demanding even for the best credits has remained stubbornly high and the result is that money is far from cheap.

The Banks meanwhile have continued the cathartic process of marking to market their ill advised loan portfolios while at the same time slowing down their overall underwriting of new loans. This combination of reduced capital and earnings has led to an industry wide pummeling of the common shares of the banks. The Dow Jones Wilshire Bank Index fell 25%+ (with Bank of America alone falling 37%).

Businesses throughout the world are also facing extraordinary challenges as many long standing models are suddenly found to be unprofitable or even obsolete in the era of $100+ oil. Given the productivity tools that have been developed in the past decade, there is opportunity to look forward to in a changing business climate. However, those changes don’t happen overnight and earnings during this period will be impaired.

Moving Forward

Perhaps the most unsettling aspect of the current climate is the sheer number of variables. As we have often said, the market can quantify bad news, but it really dislikes uncertainty, particularly of the magnitude that we are seeing right now. Consider that we are just four months from a presidential election, and market participants have yet to focus on those potential implications. However, as these various problems are being addressed, we will begin to see a roadmap, albeit with numerous paths, where markets can be stabilized and can once again move ahead.

Look for instance at the European Central Bank and our Federal Reserve and we see a tale of two approaches. The ECB, which remains to this day, strongly influenced by the former Bundesbank and the inflation that vexed the German economy in the 20th century, fights inflation first and foremost and at the expense of economic growth in its region. The Federal Reserve of the United States has the Great Depression as its seminal event and will always try to spur growth with inflation fighting as a secondary concern. These disparate approaches have led to a large spread in the respective benchmark yields and have had an unintended impact on currency valuations. Over time, these global rates are likely to once again converge and reduce the impact of the disparate approaches.

Believe it or not, there is even disagreement over what type of inflation we are currently fighting. Typically, inflation is a result of strong growth and demand and should be addressed through a system wide tightening of credit. But globally we are far from overheating and inflation is concentrated in commodities. We have significant deflation in global housing prices and we are far from seeing wage price inflation. There are those voices who suggest that the Federal Reserve should raise rates at this time, but we would argue that the demand destruction we are seeing throughout the consumer sector is going to be an even more effective governor on the US Economy than higher rates. In addition, the banks are in the process of healing and raising rates at this time and will not expedite that process.

The Recovery

The foundation for recovery has been laid. The Federal Reserve has done their work, and over the coming quarters, the banks will continue to recapitalize where need be and will reestablish an appetite for lending. Meanwhile, consumers and businesses will adjust behaviors and models to address this new world. There are businesses which will likely never be the same: airlines, autos, and Wall Street to name just a few. But at the same time, we may see a renaissance in certain types of manufacturing which may now make more sense to be done domestically given the higher costs of transportation. Furthermore, the uncertainty surrounding earnings has likely led to an overshooting on the down side of valuations. As we suggested in our last note – a little bit of stability and supply could go a very long way in an oversold market.


In this Edition

  • Black Gold
  • The Federal Reserve, The Banks, & The Earnings
  • Moving Forward
  • The Recovery

Huntington Steele

925 4th Avenue
Suite 3700
Seattle, WA 98104



Past Issues

44 - 06.03.08
Shallow Waters/ Odds and Evens/ Changing Times

43 - 04.09.08
Q1 2008/ The Call/ The Response/
Investing Opportunities

42 - 02.27.08
Credit Hangover/ Busy Banks and Brokers/ Insurance Cleanup
Risk vs Reward

41 - 01.02.08
2007-Year in Review
2008 - Outlook

40 - 11.21.07
Dealing with Uncertainty/
From King County to Hong Kong/
Silk from a Sow's ear/
Tangled Web/ Economic Slowdown

39 - 10.02.07
Trick or Treat /Dispersion/

38 - 09.04.07
Summer Unwind /Dominos/
Recent History/Lending Rev/
What's a Chairman to Do?

37 - 06.05.07
Rally Time /Attribution Encore/Outlook

36 - 04.03.07
Q1 2007: Two Sides of the Same Coin
/ Flat Water
The Need to Ease

35 - 02.28.07
Unhappy Tuesday
The Road Ahead

34 - 12.18.06
2006 - The Good, The Bad, & The Very Good
Risks and the Gift of Fear
2007 - Outlook

33 - 9.21.06
Steady As She Goes
Wide Open Range
Just the Facts
Financial Turbulence

32 - 8.11.06
The Pause
Headwinds and Tailwinds
Winning with Defense

31 - 5.19.06
Petulant Markets
What's a Chairman to do?
Recipe for Volatility
Restoring the Foundation

30 - 03.09.06
Out of the Gate 2006
A New Captain/A Long Race
The Bear's Den/ The Value of Preparation

29 - 12.01.05
Determined Not to Yield
Bond Market History Lesson
2005 Home Stretch

28 - 10.03.05
The Pennant Race
Just the Facts
Fourth Quarter Implication

27 - 08.11.05
Back to the Future
Reports of Demise
Greenspan Countdown

26 - 06.09.05
Measured Conundrum
Possible Explanations
Implications of an Uncoupled Market

25 - 04.13.05
1st Quarter 2005:
Up, Down, Sideways
Calm on Top, Turbulence Below
What's on Deck?

More Past Issues
can be found in our

Newsletter Archive


Market Highlights

12/29/06 12/30/05 12/31/04
DJIA US 11350 12262.9 13264.8 12463.20 10717.50 10783
S&P 500 US 1280 1322.70 1468.36


1248.29 1211.92
Nasdaq US 2292.98 2279.10 2652.28 2415.29 2205.32 2175.44
EAFE Int'l Equity 1967.19 2038.62 2253.36


1680.13 1515.48
5 Yr Treasury 3.316 2.447 3.457 4.676 4.355 3.649
5 Yr AAA Muni 3.37 2.9 3.29


3.50 2.79
10 Yr Treasury 4.02 3.599 4.136 4.718 4.403 4.257
10 Yr AAA Muni 4.00 3.79 3.74 3.79 3.89 3.64
30 Yr Treasury 4.523 4.288 4.46 4.799 4.497 4.817
30 Yr AAA Muni 4.87 4.960 4.43 4.18 4.39 4.58
EUR Currency 1.5788 1.5813 1.4717 1.3170 1.183 1.3652
JPY Currency 105.38 99.64 112.02


117.48 102.48
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