@theMarket: Fed-fueled Gains Support Markets
The markets embraced another 75-basis point interest rate hike by the Fed, even as the U.S. economy contracted for the second quarter in a row. Bad news became good news in today's markets.
It was not so much the hike in the Fed funds rate announced as part of the Federal Open Market Committee's (FOMC) meeting on July 27, 2022, as it was the words of Chairperson Jerome Powell in the Q&A session afterward. Although he really did not say anything new, the markets and the media interpreted his stance as more dovish, if not pivotal.
The bulls' argument is that the economy is slowing, inflation is peaking, and therefore the Fed is likely to slow, if not stop, its interest rate hikes altogether in the months ahead. This argument carries more weight now that the nation's economy fell by 0.9 percent in the second quarter, while economists expected a gain of 0.4 percent.
But the Personal Consumption Expenditures Price Index (PCE) announced for June 2022 came in hotter than expected (6.8 percent versus the 6.7 percent expected). It is a key variable the Fed watches closely, which would indicate inflation is still climbing.
Now depending on your politics, we are technically in a recession, defined by two negatives quarters in a row of declining growth. The Biden administration denies that is the official definition. Economists, according to their argument, evaluate the state of the business cycle based on a slew of variables such as the labor market, consumer and business spending, industrial production, and incomes. None of those items conclusively prove we are in a recession.
My take is if it looks like a duck, and feels like a duck, then mostly likely, it is a duck. If we are not in a recession, then the alternative would be stagflation.
Corporate earnings seem to indicate a slowing of the economy. Social media stocks, which depend on advertising for a great deal of their revenues, are seeing a strong decline in spending. Those companies that have been able to pass on higher cost through price rises are doing okay, but few companies are hitting results out of the park.
Apple, Amazon, Google and Microsoft earnings, while not great, were at least less bad than many expected. Their share prices gained (some substantially), which buoyed the market and has allowed the relief rally to continue to climb.
A surprise breakthrough between Senate Democratic leader Chuck Schumer, and Senator Joe Manchin on a whittled-down $430 billion spending program cheered the markets. The agreement would increase corporate taxes, lower the cost of prescription drugs, reduce the national debt, and invest in energy technologies that will focus on reducing climate change.
The bill is touted to reduce the deficit by $300 billion over 10 years, and lower carbon emissions by about 40 percent by 2030. It has been dubbed the "Inflation Reduction Act of 2022," although nothing in the bill except its title would have any impact on inflation this year or even next. For individuals, it would provide a $7,500 tax credit to buy new electric vehicles. It would also provide a $410 billion tax credit to manufacturing facilities for things like electric vehicles, wind turbines, and solar panels.
The cost of the compromise bill is much lower than the multi-trillion, "Build Back Better" plan originally proposed by the Biden administration. The thinking is that no Republicans in either the House or Senate will vote for the bill, so the reconciliation process is the direction Democrats will use to pass the bill. If Democrats are to be believed, the bill should pass as early as next week
It was no surprise that the sectors that would benefit most from this spending plan rose on the announcement. The alternative energy sectors gained on the news, as did oil and gas stocks. By Friday, the S&P 500 Index broke the 4,100 level and some think 4,200 will be the next level that the bulls are targeting. Could we get there, given the belief that the Fed may pause in its tightening program? Sure, but we are already over extended. We are running on empty as far as buying juice is concerned, so if we are going to get there, we need to pullback first. That may happen early next week but for now things look good at least into mid-August, and then down again.
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The Retired Investor: No End in Sight for Airline Agony
Missing bags, canceled flights, stranded passengers, and interminable check-in times have made this summers' travel a nightmare. What's worse, the cost of travelling has exploded.
Consumers are paying an average 34 percent higher air fares this year versus last. The reasons why range from higher jet fuel costs, increased labor costs and sky rocketing demand among others. As the summer season progresses, it seems that the worse the experience gets, the more consumers are willing to pay.
If you watch the horror shows on the news, chaos abounds not only here in the U.S. but in the international airline system overall. Short comings in one location, whether it be from the weather, labor shortages, lost baggage or some other cause, has an increasing domino effect that impacts airports and airline schedules throughout the country.
As the system continues to break down, airports and airlines are besieged from all sides from irate passengers to an increasingly concerned government. Readers who have firsthand experience or may be even now caught in this web of travel turmoil might ask a simple question. "How did we get here?"
The origin of this disaster has its roots in the COVID-19 pandemic. As we all know, the coronavirus devastated air travel worldwide. By 2020, airline travel was down a whopping 70 percent. To put that in perspective, the 9/11 attacks reduced travel by a mere 7 percent. For the airline industry overall, how to survive was the chief topic of conversation within corporate boardrooms.
The industry answer -- reduce employees, slash pilot headcount, sell aircraft, and retire older planes. Top airline managements were ruthless in their headcount. Delta and American Airlines, for example, laid off 30 percent of their staff, offering buyouts, early retirements or simply letting people go.
The common assumption among airline executives was that it would take five or six years to recover their former traffic. As such, managements continued to reduce their operating expenses to the bone. But the coronavirus did not occur in a vacuum. The government, together with the pharmaceutical sector, managed to develop several effective, COVID-19 vaccinations. That breakthrough reversed the six-year timetable.
The consumer suddenly became willing to fly. Travel demand turned around far faster than anyone expected, thanks to the government's vaccination efforts. The industry was caught completely off guard. But that was more than a year ago. Why is the industry still woefully unable to accommodate the surge in demand?
The scarcity of labor, which is plaguing the nation in general, is hurting airlines far more. Let's start with pilots. An army of experienced, older, industry pilots decided to retire, (or were asked to retire) and are gone forever. Hiring and bringing on entry-level pilots requires years of training.
In addition, there are myriad regulatory requirements such as clocking at least 1,500 hours of airtime before being allowed to pilot a commercial airplane. Oh, and by the way, those who train these newcomers (instructors and flight simulators) are also in scarce supply.
Hundreds of thousands of workers from cabin crews, to ground staff, to baggage handlers were also let go. Many of those ex-employees have either found new jobs or have no wish to rejoin an industry that kicked them out during the worst crisis this nation has seen in a hundred-plus years. Many of these former employees don't see the upside in a job that once again exposes them to the mutations of new COVID strains. They also have no wish to face armies of angry passengers in an industry where job security is no longer guaranteed, if it ever was.
Traditionally, airlines have depended on redundancy in their system to handle unpredictable disruptions. Think of it as insurance that if anything goes wrong, a back-up staff is there to handle it. Without the staff, airlines are at the mercy of every sudden storm, pilot absence or COVID-related sick day. Today, a sudden cancellation can cascade throughout not only one airline, but throughout the entire system.
Compounding the industry's labor shortages, are shortages of TSA and customs personnel, as well as air traffic controllers. This results in long lines that delay check-ins, which delay departures and arrivals, which keep planes waiting, and incoming passengers on planes, sometimes for hours.
I wish I could say that the chaos in air travel will pass with the summer travel season. The problem is that the labor shortages the industry faces cannot be solved overnight. Competition for workers will persist in the months ahead. Industry experts say the problems besetting the airline industry will continue into 2023.
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The Retired Investor: Local Gas Stations Suffer From High Fuel Prices
Given the price jump in gasoline, you would think owners of the corner gas station are raking in the money. Unfortunately, the opposite is occurring, especially now that pump prices have been declining for more than a month.
"The national average price of a gallon of gasoline has dropped below $4.50 per gallon after touching $5 as recently as mid-June," according to Berkshire Money Management's Allen Harris. He goes on to say that despite the 10 percent decline, gas is still up 9.3 percent over the last three months. That brings the year's gain thus far to 36.8 percent
In an environment of higher gasoline prices, consumers are hurting. Drivers naturally tend to blame the most visible object of their distress, which is their local gas station. At the same time, gas station owners are also the target of President Joe Biden, who is accusing them of profiting from higher gas prices. Four California cities are so angry with gas stations that they have banned the opening of new gas stations.
The truth is that most gas stations tend to drag their feet in raising prices. They know that most consumers have no loyalty when it comes to filling up. The lowest advertised price usually wins the day and higher prices mean lost customers. A look at the typical owner's business model explains what is going on behind this energy crisis.
The way it works most often is that when a gas station refills its tanks, it purchases many weeks' (if not months, in the case of diesel) worth of fuel at a single high price. And let's say they did so in mid-June when gasoline was over $5 a gallon. If prices begin to fall (as they have this month), the gas station is forced to sell the product at below its' own cost.
Most gas stations barely turn a profit on their core product at the best of times, and when oil spikes, they may even take a loss on it. Gas stations, according to IBISWorld, an industry market research firm, make an average net margin of 1.4 percent on their fuel. A lot of operators set their profit margins as a fixed rate, which only amounts to a few cents at best. Remember too, that when gas prices climb, so do the fees the owner must pay out to credit card companies, since their fees are set on a percentage basis. Rising gas prices after credit card fees can easily erase the stations' profit margins altogether.
The facts are that station owners make most of their profits on sales of food, drinks, and alcohol (where sales are legal). In this scenario, think of gas as a loss leader. The National Association of Convenience Stores believe that 44 percent of gas station customers go inside the store. One in three customers ends up purchasing something. Gross margins on certain items such as candy, health and beauty items can be as much as 50 percent. The trend toward selling more prepared foods, which have higher margins than the usual fare of chips, Lotto tickets, coffee, etc., helps as well.
Many readers believe that big oil companies own most gas stations, so why feel sorry for them? All those Shell, ExxonMobil, and Chevron signs we pass on the freeway are proof positive, right? Wrong. Most major oil companies have long-since backed out of the retail business because selling gas isn't profitable. The reality is that 80 percent of the gas bought in the U.S. is purchased from a franchised convenience store that is individually owned, no matter what brand of oil they may sell.
It may surprise you to know that the number of gas stations has been in a decline for decades. Higher oil prices are one of the chief causes of their demise. The spike in energy prices in 2008, for example, forced hundreds of gas stations out of business. Further competition in the form of big box stores that can purchase fuel in bulk at lower prices has also eaten into the mom-and-pop stores' market share.
Finally, the rising number of electric vehicles in use now and their growing popularity into the future will also reduce the number of stations. Despite the EV threat, few stations have made the costly decision to install EV charging units, which can cost more than $100,000 each.
So, the next time you fill up, while clenching your teeth as the dollars mount up, just remember that it is not always the gas station owner who is gouging you. In truth, the object of your anger is misplaced. Look half a world away, where war rages, and cartel quotas dictate the price we pay for oil.
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@theMarket: Market Beat Down
Rising inflation, weaker earnings expectations, or the rocketing U.S. dollar, it is just a question of which of these negatives are hurting the markets most. Investors are frightened, but not yet panicked. It is time to pay attention.
Both the Consumer Price Index (CPI) and the Producer Price Index (PPI) for June 2022 came in hotter than economists expected. They are backward-looking indicators, but markets fell on the reports, nonetheless. Rising energy prices was the biggest culprits in both reports hamstringing consumers and producers as prices soared. Since then, the price of oil has dropped, although natural gas prices have risen, so we will have to wait and see how much energy impacts this July's data.
However, with the higher year-over year CPI gain of 9.1 percent, coupled with the PPI's gain of 11.3 percent, the bond market is now betting on a one-in-two chance of a super-sized move in July's FOMC meeting of as much as a 100-basis point. Another 75 basis points is now also in play for the Fed's September meeting.
Corporate earnings for the second quarter kicked off this week. The money center banks announced poor earnings and even gloomier guidance. Investors have been expecting disappointments across the board, although some argued that poorer earnings were already reflected in the price of the stocks. Tell that to JP Morgan, the premier U.S. banking company, that saw its stock fall by more than 4 percent.
But the most troubling event is the continued climb in the U.S. dollar. I have advised readers over the last month to watch the level of the greenback. It is now trading at parity with the Euro. The last time this happened was in 2002, but it is not just the Euro. The dollar has been hitting 20-year highs against the currencies of its major trading partners as well.
As I have written before, a currency's exchange rate is a reflection on a country's economic prospects. In the case of Europe, higher energy prices, the Ukraine war, and record inflation have damaged the prospects for economic growth. As the European Unions' energy supplies dwindle, inflation has climbed by more than 8 percent and talk of rationing national gas supplies to industries is now on the table.
The European Central Bank (ECB) is between a rock and a hard place. If they raise interest rates to combat inflation, it could have a disastrous impact on the EU economy, which is already teetering on the edge, thanks to the war and energy embargos. But going slow on tightening monetary policy will only fuel higher inflation.
The U.S. may be facing its own bout of recession for some of the same reasons. The difference is that our Federal Reserve Bank has been more aggressive in tightening monetary policy than the ECB. And while energy prices are high in the U.S., they are still lower than in Europe. Natural gas prices, for example, are ninefold higher than in the U.S.
As far as currency markets today, it comes down to who has the cleanest shirt in the dirty laundry basket. The U.S. dollar wins that contest hands down. However, the downside for many American companies is that revenues and earnings generated overseas, and then repatriate are worth less. If instead, managements decide to keep their Euro earnings in Europe to cover costs there, the exchange rate becomes less of an issue. Another downside is that a stronger dollar makes American exports more expensive, which reduces U.S. economic output and widens the trade deficit.
Over the last week or so, Wall Street analysts have been scurrying to reduce their earnings estimates for more than 500 companies for this second quarter. It would not surprise me if equity strategists began to reduce their year-end estimates downward for the market averages. Talk of a more aggressive need to raise interest rates sooner than later to combat inflation, coupled with recession fears, is the motivating factor behind these moves.
The next FOMC meeting is drawing closer (July 26-27), which won't be good news for the markets, and in the meantime, we have an earnings season to contend with. At best, I expect to see a volatile market as earnings surprises, both positive and negative, send markets careening up and down through the rest of the month.
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The Retired Investor: Public Sector Can't Compete in Tight Labor Market
State and local government employees are essential in delivering everyday services to the American public, but the government's labor force is understaffed and has yet to recover from its pandemic lows. The reasons range from lower pay and less advancement to little flexibility in areas such as remote working.
Private-sector jobs have already surpassed pre-pandemic levels, while in the public sector, government employers are still looking for more than 664,000 workers with little success. This may sound like one of those "so what" kind of issues but consider this.
Public employees operate the nation's trains, subways and buses in addition to delivering essential services like health and unemployment insurance. Also on the list; safety-net services such as housing and cash assistance, protecting the nation's water, food, and air as well as combating infectious diseases. And let's not forget the increasingly difficult duty of teaching and caring for our kids in state universities, community colleges, and K-12 education.
I focus on teachers especially since jobs in education account for most of state and local employment, according to the U.S. Census Bureau. Teaching salaries have the reputation of being notoriously low in the best of times, which these are not.
The ongoing pandemic, now in its third year, provides a clear and present infection danger for all teachers. Throw in the increasing number of school shootings, and the tension that goes along with it daily and you can understand why teachers have been retiring in droves with few replacements.
The increasing political pressure from outside the classroom on everything from facemasks, to books, to what lessons plans will be least likely to cause turmoil and/or outrage among parents adds to the teacher's list of grievances. No wonder, that, with a laundry list like that, it becomes even more difficult to woo young teachers for $50,000 a year when the same graduate can earn twice that and more in the tech industry.
Workers considering employment in areas like education, the postal service, etc. are being wooed away in this tight labor market by hefty signing bonuses and faster wage growth in the private sector, which becomes especially important in an inflationary environment.
You would think the simplest solution would be to raise wages for government employees just like the private sector has been doing. That turns out to be a rather difficult proposition. In the past, state and local governments struggled with a combination of cutbacks in federal spending (depending on who was in office), as well as low tax receipts from time to time. This made budgeting difficult and somewhat unpredictable.
Which brings us to government budgets. For the most part, it is the budget that determine salaries for public workers. Budgets, as we know, are ponderous things that take a long time to pass, and almost always involve political horse-trading. Raising wages for government workers, therefore, is a hot potato that few politicians are willing to tackle unless they must.
Another disadvantage in finding workers is that government work is not as flexible. Working from home doesn't cut it for a bus driver, police office, or letter carrier. Therefore, hybrid and remote work options just aren't in the lexicon of most state and local governments. So, who suffers the most from these lower wage jobs?
In the overall economy, state and local governments account for about 12 percent of employed people. Most of these workers are women. Workers of color, particularly Black and American Indian employees, are also heavily represented in these industries. As such, public sector employment has provided economic security for women and minorities.
Is there a solution to this employment problem? Probably, but not in the short term. However, as the wait time between your bus or subway stop lengthen, the lines at your unemployment office, or at the tax assessor's office trail out to the sidewalk, and your mail is two weeks late, we will notice and complain. At some point, if we yell loud enough, things will change, but I suspect not before they get much worse.
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