Brennaman's Four Points For The Week February 16, 2015

1.            Ukraine and Iraq – Pick Your Poison – Parties on both sides have agreed to a ceasefire but not after fierce shelling and firefights for the two days leading up to the start of the accord.  The leadership of the separatist groups has not been part of the discussion, rather Vladimir Putin has been the surrogate negotiator – this is interesting since he has “no soldiers” in the fight.  The U.S. for good or bad cannot decide on a cohesive course of action for aiding the Ukrainians or helping bring the accord into being.  Iraq presents similar problem but more pressing as ISIS appears to have “discovered” the army base that houses U.S. personnel sent there to train Iraqi security forces.  This attack, while unsuccessful, threatens to pose a situation where U.S military personnel are thrust into a direct combat role just to provide for their own security.  This would clearly widen the conflict and bring the U.S. into a more active participant on the ground versus airstrikes.  Iraq or Ukraine poses significant challenges to the U.S. and the administration reluctant to enter into another ground war even as the Afghanistan war effort is coming to a fitful close.  Our position as leader of the free world (which does not necessarily include Russia) may set the decision before us – Do we really have a choice?  The situation in Yemen is a topic for another day.

2.            Economy – Inflation as A Result of Western Port Slowdown – Trade traffic through western U.S. ports halted at midnight on Wednesday as port owners (facility operators actually) stopped all loading/unloading activity for the long holiday weekend (essentially a five day lockout).  Longshoremen and related workers to include truck drivers, crane operators and laborers were told there was no work for them this weekend and that no ships would be offloaded therefore no containers to depart via rail or road modes.  Meanwhile ship commerce to these ports is piling up in the form of laden ships with goods bound for U.S. manufacturers, producers and consumers.  And the dollar counter continues to run as costs to the receivers of these goods are picking up the tab for the goods to sit on these ships.  This additional cost will likely result in a slight pickup in producer prices and hence consumer prices; and that is if the lockout is indeed short-lived and offloading resumes at a normal pace.  The normal pace for the last 7-9 months has been but a fraction of the normal pace before contract negotiations fell apart last summer.  The inflation impact will be temporary but if the lockout continues or the work slowdown resumes the broader impact on the economy could set back the growth rate of the country’s economy just when we appeared to have turned the corner.  You will recall these ships have no choice but to go the western ports since the Panama Canal cannot handle the majority of these ships due to their size and to make the trip around Cape Horn or through the Middle East is prohibitive in cost and dangers.  The true cost of the port closure/slowdown will be in lost production, lack of goods to sell and a reduction in profits.  All drags on the U.S. economy.

3.            Corporate Earnings – Growth is a Good Thing, But Is It Enough? – The earnings season is progressing and for the most part Wall Street is pleased with the results from the fourth quarter.  As of Friday, 378 of the 500 companies of the S&P 500 have reported with 71% of companies beating estimates, 11% matching and 18% below expected earnings.  These results created a blended earnings growth rate (for the Index) of 6.5% for the quarter which is more than respectable.  The growth rate for the entire 2014 season was 10.3%.  This is in line with the consensus earning’s estimates most street analysts had at the beginning of the year.  A recent report (U.S. Census Bureau) stated that retail spending fell .8% in January worse than the consensus of -.5%; this following a decline of .9% in December.  The biggest contributor was a dive in gasoline station sales was and new automotive sales.  Interestingly enough spending at restaurants including casual dining was up in January and in December.  Nonetheless consumer spending in the fourth quarter of 2014 was robust and consumer related stocks had corporate earnings gains of 13.2% for the quarter; third highest recorded in the index behind Healthcare (22.7%) and Technology (17.6%).  Another view of the picture has to do with revenue growth.  Revenue growth to date is 1.9% for the fourth quarter, a significant decline from the third quarter (4%) but the growth for the year stands at 13.7% (also in-line with estimates) with 20% of the companies left to report.  But it is expected these revenue numbers will keep pace with the previous results.  All in all these earnings numbers are about where we would expect them to be in a slow growth economy but they do beg the question are they strong enough to sustain the economy in light of the struggles in the European Union and the emerging markets?

4.            Federal Reserve Watch – The Focus Is On The Growing Economy – The Federal Reserve Open Market Committee’s (FOMC) will not meet again until March 17 so they have time to evaluate the economy as well as the health of our partners in the European Union.  Aside from Germany most of the European Union countries are approaching the edge of recession if they have not already gone into residence in that egregious zone (Greece comes to mind but Italy has been in recession for nearly four years).  While these situations are point s of interest, the FOMC is focused on the trifecta of information they need to study before deciding to raise short term interest rates.  Namely, unemployment (including wage growth), inflation level (target is 2%) and the overall status of the country’s growth (gross domestic product – currently sitting at 2.6% annualized through Dec 2014).  Real inflation simply does not exist.  Excluding energy and food it is at .8%.  There will be some temporary price increases if the port situation in the western cities is not resolved but longer term the impact may be negative on the GDP growth as goods may not be available for production or sale.   The impact of six weeks of brutal cold weather in the eastern half of the country could also impact the growth rate in the GDP (remember 1Q 2014?).  We are also facing a slowdown of exports due to the stronger U.S. dollar and the increase of imports due to higher demand here.  Anecdotally the stronger dollar helps drive imports higher, keeps prices lower but we are witnessing a dramatic reversal of the trade deficit which has declined over the last three quarters, this gap is now widening again.  On top of all this the flow of investment dollars continues to fly into U.S. equity and fixed income markets as we have positive yields on our government bonds, solid corporate earnings, a growing economy and a reliable currency for trade.  All of these are issues for the FOMC to grapple with as they decide when to make the move towards higher interest rates.  Meanwhile the equity markets are seeing significant strength after a disappointing January with the three major indices (DOW, S&P and NASDAQ) hitting all-time highs this week.  Clearly the mantra of do not fight the FED is being adhered to as investors seek solace in the equity markets, seeing them as the only clear alternative in the investing market.

“You recognize but one rule of commerce; that is (to avail myself of your own terms) to allow free passage and freedom of action to all buyers whoever they may be.” François Quesnay.

Have a good week and be aware that the cold weather is haunting us still.

Steve