Beware of Demand Destruction/Market Update

Good afternoon folks!

Well it was another Freaky Friday in the markets. We started off the day with good news in several areas. Consumer sentiment rose from its recent lows. GDP growth and new home sales were both better than expected:

"July 25 (Bloomberg) -- Orders for U.S. durable goods unexpectedly rose in June, and sales of new homes were higher than forecast, easing concern that the economic slowdown will worsen.
Bookings for goods made to last several years gained 0.8 percent and posted the first consecutive monthly rise since July 2007, the Commerce Department said today in Washington. New homes sold at an annualized pace of 530,000, exceeding the median forecast of 503,000 in a Bloomberg News survey. A private report showed consumer sentiment rose from a 28-year low."

My take:

Oil also dropped into the low 120's. After seeing the news this morning, I was expecting a rocket shot bounce back from the turbulence we hit yesterday. To my surprise, the DOW really never bounced. We were up about 100 points but then faded going into lunch.

The bulls must be feeling dazed and confused. 3 years ago this would have rocketed the DOW up 300 points by lunchtime. There is definitely a "crisis of confidence" that has hit Wall St. Is it the SEC? Bad economy? Financial shoes that continue to drop?

I think its a little bit of everything.

Demand Destruction

I want to spend some time on the big drop in oil prices the last few weeks. Oil has been dropping for one key reason: Demand destruction. Now one would think lower oil would be bullish for the markets. However, when its caused by demand destruction, you need to use this as a giant warning sign that the economy is in deep doo doo.

Think about this for a second. Putting gas in your car is a necessity. Almost all of us need to drive in order to work, pickup the kids, and buy groceries.

So I ask you a question. What in the hell is consumer spending going to look like in the next few quarters if people can't even afford to put gas in their car?

If they can't afford to put $50 in the tank then they definitely aren't going out and buying a $1200 plasma TV. Go walk into a Best Buy and look at the prices. They can't give the stuff away.

Been to a care dealership lately? You can get the deal of a lifetime on an SUV right now. Look at the Chrysler news that hit the markets today:

"July 25 (Bloomberg) -- Chrysler LLC, hurt by plunging prices for used sport-utility vehicles, said its finance unit will stop offering leases to customers on Aug. 1.

Dealers can still make leases obtained through independent finance companies, President Jim Press said today. Rising borrowing costs drove up consumers' lease payments, helping spur the shift, Press told reporters on a conference call.

Other automakers may have to join Chrysler as $4-a-gallon gasoline forces lenders to cut so-called residual values for leased SUVs and other vehicles at the end of their terms. Ford Motor Co. took a $2.1 billion second-quarter charge yesterday to write down leased vehicles owned by Ford Motor Credit."

Final Take:

So much for the days of leasing a car. The reason they need to stop leasing is they can't sell the SUV's after the leases are up. They are getting killed. I think the big 3 are all in deep trouble. This is the last thing Chrysler wanted to do because its a big chunk of their sales.

However, drastic actions must be taken when you are on the brink of going bankrupt. This is going to make it more expensive to buy a car because a car loan will be your only option unless you are paying cash. If you have an average credit score then your cost of a new car just went through the roof.

The credit crunch is going to impact everyone in more ways than most of us realize. Interest rates are going to go up on everything, and access to credit is going to be drastically reduced as the banks recover. This is going to suck the wind out of the consumer.

Another since of further financial woes was the S&P downgrade on Fannie/Freddie today:

"July 25 (Bloomberg) -- Standard & Poor's may downgrade the subordinated bonds of Fannie Mae and Freddie Mac, surprising investors who had anticipated the securities would be supported by any Treasury rescue plan
.
The potential cut would affect $19.2 billion of AA- rated subordinated debt at Fannie Mae and Freddie Mac, according to data compiled by Bloomberg."

Bottom Line:

The trade of buying stocks as oil drops is losing steam as signs of weakness continue to rear their ugly heads. Demand destruction in oil means you will be seeing demand dropping in all parts of the economy. In other words "If people ain't driving then they ain't spending!"

The timing of the Fannie/Freddie news was a signal to Congress by S&P. The way I see it, the ratings agencies are guessing equity holders might be screwed if this bill passes.

It just happens the vote on this bill is this weekend. I think the markets fired a warning shot to Congress. When you cross the line of "moral hazard", there are consequences.

Lets all hope that the Senate or Dubbya puts the kabosh on this dangerous legislation.