But don’t expect that to last. A slump in consumer spending and soaring unemployment could both pose a significant threat to retailers going into the 2009 holiday season.

The U.S. unemployment rate hit 9.5% in June and could eclipse 10% by the end of the year, sending the economy into a “jobless recovery.”

In a speech to Congress on May 9, Federal Reserve Chairman Ben Bernanke cited a lack of consumer spending could serve as a constraint on hiring. This could create a paradoxical effect as employment obviously plays a key role in consumers’ spending habits.

Even for the employed, the lessons learned from the worst economic downturn since the Great Depression will resonate with consumers. That has already been evidenced by the U.S. savings rate, which has climbed above 4% for the first time in more than a decade.

In addition to taking money out of the hands of potential customers, soaring unemployment could lead to higher lending standards. As unemployment rises, so too will credit defaults and the cost of credit will increase accordingly.

In the past, consumers have counted on attractive financing promotions for the purchase of big-ticket items such as high-definition televisions and kitchen appliances. But that won’t be the case with tighter credit

“Consumers were also able to spend more because of the easy availability of credit, most notably through mortgage equity withdrawal and they responded by buying more items,” said Deloitte Strategic Advisor Richard Hyman.  “These conditions underpinned retail growth for the past 10 years but have now disappeared. However, it’s worse than that. They will clearly not return once the recession is over.”

Of course, tighter credit isn’t just a problem for consumers.

A Brick & Mortar Inventory Crunch for the Holidays?

The potential bankruptcy of commercial lender CIT Group Inc. (NYSE:CIT) could be a major tipping point for businesses that rely heavily on credit. Vendors for retail giants such as Wal-Mart Stores Inc. (NYSE:WMT) and Target Corp. (NYSE: TGT) rely on CIT for factoring – an old form of finance in which the lender pays the vendor for its accounts receivable. If the retailer fails to pay for the goods, the lender assumes the responsibility to pay the vendor.

“Right now our industry is preparing for the fall and winter season,” Kevin M. Burke, president and chief executive of the American Apparel and Footwear Association told The New York Times. “A lot of these orders are going to come to a grinding halt if there is no capital.”
A CIT bankruptcy would be a “double whammy” to stores whose suppliers have already cut the amount of merchandise they are making to better align inventory with the drop in consumer spending, said Burke. If those suppliers lose their sole source of capital, what little merchandise retailers originally ordered might never arrive.
The timing of CIT’s woes is “terrible,” Al Ferrara, a partner in retail and consumer products business of consulting firm BDO Seidman LLC said in a Reuters interview. “Retailers now are basically gearing up for the back-to-school and the fall season.”
An inventory crunch at brick & mortar retailers would give a competitive advantage to online retailers, which have more flexibility and already account for about a third of holiday retail sales.

For brick & mortar retail businesses, managing inventories during the holiday season is a delicate balancing act in which managers must walk a fine line between over- and under-ordering stock.

If retailers overstock, they will be forced to offer even steeper post-holiday discounts than they would like in a desperate bid to unload inventory. But if they don’t stock enough merchandise to meet demand they risk not only missing out on sales, but driving potential customers to online retailers, such as Amazon.com Inc. (Nasdaq: AMZN) whose warehouses are not restricted by the display racks and checkout counters found in brick & mortar stores.

This doesn’t mean brick & mortar retailers will sit idly by this holiday season as Amazon siphons off customers via the Internet. All of the nation’s biggest retail players have their own websites too, but the gap between Amazon and the No. 2 online retailer, Staples Inc. (Nasdaq:SPLS) is huge: Amazon generated $19.2 billion in online revenue in 2008, while Staples generated less than half of that in the same year: $7.7 billion.

While half of the top 10 online revenue generators came from traditional stores, notably absent were brick & mortar discount giants Wal-Mart and Target.

And even Best Buy Co. Inc. (NYSE: BBY), which displays in-store signage promoting an “expanded assortment” of products online for consumers who did not find what they were looking for in the store, came in at just No. 10 on the list.

Shopping for a Silver Lining

While a continued slump in consumer spending would benefit no one, certain retailers are better positioned than others, and could ultimately use adverse economic conditions to turn a profit.

For instance, the aforementioned Amazon.com, which is the world’s largest online retailer, could see a sizeable boost in its web traffic as consumers comb the Internet for bargains.

Companies that have a consumer-friendly economical brand, such as Wal-Mart, will also benefit.

Wal-Mart’s “Save Money, Live Better” slogan is already resonating with consumers, and The No. 1 retailer in the world has gone to great lengths to cement its reputation as the affordable choice for shoppers.

The company has set up a “Save Money, Live Better” website (complete with testimonials of what people are doing with the money they save by shopping at Wal-Mart) and a “Live Better Index,” which includes an interactive map of the United States to show how much money people have saved in each state by shopping at Wal-Mart.

The result of Wal-Mart’s efforts? Holiday sales grew 7% last year, according to the Advertising Research Foundation.

Similarly, same-store sales are consistently rising at discount houses such as Family Dollar Stores Inc. (NYSE: FDO), and Ross Stores Inc. (Nasdaq: ROST), the latter of which has the “Dress for Less” sloganright under its name at every store. On the flip side, stores like Macy’s Inc. (NYSE: M) and Saks Inc. (NYSE: SKS) have reported consistent declines in same-store sales over the past few quarters.

“Needs-driven spending will gravitate towards retailers able to tick the most important consumer boxes like price and convenience,” said Deloitte’s Hyman. “Although it will remain the engine of retail growth, wants-driven spending will slow and consumers will be much more choosy.”

Source: Retail Sector Faces Uphill Climb in 2009

Earnings Announcements: BKS, FL, GME

Monday

Earnings Announcement: LOW

Tuesday

Economic Reports: Building Permits, Housing Starts

Expectations are for both of these reports to show a modest improvement versus the previous month. With the deteriorating housing market, I don’t think these reports will meet expectations. Until the existing inventory is whittled down, these reports should show a drop in permits and starts. Of course, I have been wrong before, but I can’t imagine any builder wanting to add more inventory to the drastic oversupply right now.

Earnings Announcements: HD, HPQ

Wednesday

Economic Reports: FOMC Minutes

The market will scour these minutes for any indication of the Fed’s future course on interest rates. With inflation a growing concern, this becomes an even more important ‘heads up’ for possible moves.

Earnings Announcements: TGT, SKS, LTD

Thursday

Economic Calendar: Philadelphia Fed

This report will give some insight into the manufacturing sector in the tri-state area. Is it possible the report will show some good news? Perhaps. The report is expected to show a reading of -18, which is a marked improvement from last month’s reading of -24.4. The report is moving in the right direction, which means less contraction in the manufacturing sector.
Source: Housing Back In The News, More Retailers Report Earnings

He also shares a British health care conglomerate that provides aid for troubled times and “sells even better when folks are broke.”

This from Adam:

Buy into Eastern Europe’s depression or just make 114% on ours: It’s your shot to call.

In case you hadn’t noticed, retail is in a bit of a pickle these days. The Conference Board’s latest consumer poll puts their Confidence Index down another 12.4 points, to yet another all-time low at 25.

Keeping in mind that anything below 50 is considered bad, I’d have to say that a score of half that ought to be considered really bad.

No shock there, I suppose, since we are looking at massive unemployment right about now. As of late last week, the official figure had us at 8.1%, a 25-year high water mark for folks who are slowly sinking under water.

And that’s only looking at it percentage-wise. Our population has grown roughly 45% since 1985, and 140% since 1930, so it’s safe to say that there are probably more folks hanging around the corner wasting time then ever before in the history of the country, including the dark days of the Great Depression.

Depressing indeed, but before you start thinking this is another one of Lass’ loads of unalloyed dreck, I actually have found another one of those oddball companies looking to expand during this dismal episode.

But First… More Dreck!

There is an odd thing about the current wreckage. Back in 2000, the majority of American households were involved in the stock market in one way or another. This was the dawn of online investing, when most any shmoe who could type their name with two fingers could get a trading account. Inside the biz, many still refer to the tech boom and ensuing crash as the “March of the Morons.”

Not very nice, but there it is. But don’t fret too much, because this most recent crash was in many ways the exact opposite. This time around, it was the wise guys themselves who sank trillions into unfathomable, unvaluable, and in the end, valueless debt arbitrage. The very folks who should have known better fell deepest into the briar patch.

As a result, mega-discounters like Wal-Mart (WMT:NYSE) are actually reporting modest but significant increases in sales, while high-end outfits Saks (SKS:NYSE), Nordstrom (JWN:NYSE), and Ann Taylor (ANN:NYSE) are reporting withering sales declines.

The folks in the Ann Taylor corner suite at 7 Times Square (one wonders how long they will be able to afford THAT address eh?) are specifically blaming the 20% plunge in Q4 on the fact that a remarkable number of women no longer require the “business attire” that is ANN’s stock in trade. The future is so “volatile” right now (that’s biz slang for “god-awful”) the team at ANN won’t even put out a forecast for next quarter.

If you didn’t turn every $1000 you invested last year into 113 GRAND, you really need to give me the next five minutes of your time…

As the Dow lost 40% of its value in 2008, one unorthodox analyst steered his readers to optimized one-year gains of 6,635%, 10,838%, and 11,359%.

Here’s how to get eight months worth of his biggest gainers for 2009 FREE…

The Two Fashion Items That Sell Even Better When Folks Are Broke

But there is one “wearable” shop that is not pulling in its horns. In fact, it is looking to expand its offerings into Eastern Europe. And yes, they know that the once-and-future Eastern Bloc is melting down as fast as (if not faster than) we are here in the States. In fact, they are counting on it.

I am referring to SSL International PLC (SSL:LN). This Brit healthcare conglomerate has the rights to distribute Dr. Scholl’s foot aids overseas. Just imagine all those sore, tired guys pounding the pavement looking for jobs! But SSL’s real winner in these troubled times is their Durex condoms line.

As per Chief Executive Officer Garry Watts, SSL intends on using the downturn to bump its stake 50% in a unit that distributes contraceptives to Russia and nine other eastern European countries. And that’s just the first kiss, as it were: By 2010 they hope to buy up the entire operation.

Blunt and to the Point

In a recent interview with Bloomberg’s Kari Lundgren and Howard Mustoe, Watts put it rather succinctly: “Russian people aren’t going to stop having sex any more than British people are. We’re not immune from the downturn, but it’s a bit like Pizza Hut: If you’re not going out, then you might be willing to drop a five-pound vibrator ring into your trolley.”

Hey, he said it, not me, folks. Okay, stinky feet and Russian condoms are slightly unsettling thoughts (especially around lunchtime). But Watt’s got a point and he’s grinning when he makes it, which makes him different than 95% of the CEOs I speak with these days, who can barely manage a forced rictus smile.

If this is just too much for you to wrap your mind around, and you still want to grab a piece of the action in the “Retail Space,” you can always pick up some of the puts we are recommending in my own WaveStrength Options Weekly column.

Like I mentioned earlier, no one is buying luxury goods. Thus, our Best Buy (BBY:NYSE) play is up some 40% as I sit to write, while our Disney (DIS:NYSE) play is up 114%.

Source: Pick Me Up a Three-Pack When You Go Out, Dear

Considered to be a beneficiary of the tightened household budgets, the company reported a paltry 1.7% increase in same-store sales. As a result, it cut its earnings outlook.

Thomson-Reuters was right about one thing, though: Higher-end retailers got spanked – some of them quite dramatically. For example, Saks (NYSE: SKS) posted a 20% decline in same-store sales, while Gap (NYSE: GPS) sales sank by 14%.

So how can investors play this? If you’re like me, when bad news hits, you look to snap up quality companies on the cheap. But retail stocks are just too dangerous right now. While taking the opposite approach of the main sentiment often pays off, I expect retail to head lower for the next few months.

If you’re looking for bargains, buy the retailers’ goods, not their stocks.

A New Cold War

No progress.

That’s the verdict from the latest round of talks aimed at solving the increasing crisis over Russia’s decision to cut off gas supplies to the Ukraine – one that is affecting gas supplies throughout Europe in the depths of winter.

European Union officials, plus those from Russia and the Ukraine were set for more negotiation in Brussels today, but those talks were cancelled, despite a meeting between Russia’s Gazprom CEO Alexei Miller and Oleg Dubyna of Ukrainian firm Naftogaz in Moscow on Wednesday evening.

The dispute stems from a disagreement over prices, contracts, unpaid bills from the Ukraine to Russia in 2008, and Russia’s accusations that the Ukraine has stolen gas from pipelines that pass through the country. And as tensions have risen, Russia shut the taps off a week ago – a move that has resulted in some EU nations (mostly in eastern and central Europe) seeing their gas supplies dramatically curtailed, or cut off entirely, because Russia accounts for about 25% of EU gas supplies – 80% of which are pumped through the Ukraine, according to the BBC.

Countries not receiving any gas at all from the Ukraine include the Czech Republic, Romania, Greece, Austria, Bulgaria, Hungary and Croatia.

Flash back two years and you’ll find a mirror image of the situation today, when Gazprom and Ukraine battled over gas supplies and caused shortages in several EU nations.

This dispute will eventually be resolved, but with much of the EU in the midst of a brutal cold spell, it can’t come soon enough. Meantime, Gazprom has vowed to pump extra supplies to the EU through other non-Ukrainian pipelines.

Source: Retailers Battle Sales Slump… Bank Of England Battles Recession… Russia And Ukraine Battle Each Other

Even bellwhether Wal-Mart Stores Inc. (WMT), which had managed to dodge the cold winds of recession over the past year, was clobbered by the economic meltdown.

The discount retailer missed big on its December same-store sales numbers.  And across the board, a chorus of large retailers chimed in with similar, disappointing news.

Altogether, it may add up to the worst holiday-shopping season in four decades, as rising unemployment and tightening credit forced consumers to the sidelines during the all-important fourth quarter.

Citing the impact of slower than expected sales at its Sam’s Club warehouse stores and international units, the WalMart posted a 1.7% increase in same-store sales. The world’s largest retailer also cut its fourth quarter earnings forecast.

“The current economy remains challenging for all businesses, and retailers have already seen customers pull back on discretionary spending,” Tom Schoewe, Wal-Mart’s finance chief told the Financial Times. “Consumers are very focused on value and necessities.”

At first, consumers had crowded discount stores seeking lower-priced goods, but surprised investors must now cope with a retail environment where even Wal-Mart seems vulnerable.

“I am shocked and disappointed,” retail analyst Britt Beemer, chairman of America’s Research Group, told CNNMoney.com.  Because of its low prices and aggressive discounts, Beemer had pegged Wal-Mart as the clear winner of the holiday shopping season and was expecting the retailer to post a 3% sales gain in December.

Overall, same-store retail sales dropped 1.7% in December, the International Council of Shopping Centers reported. Same-store sales measure sales at stores open for more than a year, and are considered to be an important indicator.  Sales declined 2.2% in the last two months of the year – the biggest such drop since the group started tracking the data in 1970.

Damage was widespread and deep, pummeling not only discounters but high-end marketers. Same-store sales at luxury retailer Neiman Marcus Group Inc. sank 28% in December. Saks Inc. (SKS) posted a 20% sales decline, twice as large as analysts estimated, even after markdowns of as much as 70% on designer goods.

Macy’s (M) said same-store sales fell 4% and it will close 11 underperforming stores in nine states, affecting 960 employees. The department store chain expects to earn between 90 cents and $1 per share for the quarter ending Jan. 31, below the consensus estimate of $1.12.

“This has been the most challenging economic environment in memory,” Macy’s CEO Terry Lundgren said in a statement.

Any sales rebound in the coming year will have to weather strong headwinds from surging unemployment.  Although initial unemployment claims fell last week, they are still up 42% over 2007, the Labor Department reported.  Continuing claims rose by 101,000 to 4.61 million in the week ending Dec. 27, the highest level since November 1982.

The Labor Department is set to release the December jobs report today (Friday). Economists had expected a loss of 500,000 jobs last month, but many are revising forecasts upwards.  A report from payroll processor ADP projected job losses of 693,000 as reported by Money Morning on Thursday, capping what could be the worst year of job losses since the end of World War II.

And in more bad news on the unemployment front, Walgreen Co. (WAG) the nation’s No.2 drugstore chain said it is eliminating about 1,000 jobs, or about 9% or its work force.

“That does not bode well going into January-February, where we go into a lull period and there’s really no reason to buy until spring,” Adrienne Tennant, an analyst at Friedman, Billings, Ramsey & Co. (FBR) in Arlington, Virginia, told Bloomberg Television.

Even the good news was bad. J.C. Penney Co. (JCP) same-store sales fell 8.1%, better than it and analysts had estimated. Kohl’s Corp.’s (KSS) dropped 1.4%, helped by last- minute shopping and “strong post-Christmas business.” Analysts had anticipated a 5.9% decline.

But the lackluster results at most discounters were a huge, negative surprise.  Costco Wholesale (COST) reported a 4% drop in same-store sales for December, a bigger decline than the 3.7% analysts had expected.

Target’s (TGT) December same-store sales fell by 4.1%. The retailer said this was in line with their expectations but that it had to slash prices to clear inventory.

“These markdowns, combined with additions to our accounts receivable allowance, will put additional pressure on our profitability in the fourth quarter,” the company said.

“This kind of discounting is a big concern,” Retail Metrics President Ken Perkins told Bloomberg TV. “January will be a heavy clearance month, with further downward margins pressure, and we might see more forecasts cut.”

It’s almost like Pavlov’s dog,” said Craig Johnson, president of retail-consulting firm Customer Growth Partners LLC in New Canaan, Connecticut.  “Consumers have become so accustomed to markdowns that nobody wants to pay full retail anymore.”

Source:Blue Christmas for Retailers as Slumping Economy Hammers Sales

But the question is – which ones?

In the financial services sector, 2008 was a year of spectacular failures:

• Bear Stearns Cos. and Merrill Lynch & Co. Inc. were absorbed by JP Morgan Chase & Co. (JPM) and Bank of America (BAC), respectively.
• Lehman Brothers Holdings Inc. (OTC: LEHMQ) filed for bankruptcy protection.
• And financial-sector giants American International Group Inc. (AIG) and Citigroup Inc. (C) were both bailed out a vast expense to taxpayers.

If at the start of 2008 I’d written that the entire New York investment banking business would disappear during the year, you’d have thought me a madman. But it has. The two houses still standing, Goldman Sachs Group Inc. (GS) and Morgan Stanley (MS), are both now officially conventional banks, with lower leverage ratios and a changing business mix.

In the New Year, we’ll see less turbulence in financial services than in 2008, if only because it would be almost impossible for it to have more. The dangerous process of de-leveraging becomes less dangerous as leverage itself is reduced, and the capital injections from the Troubled Asset Relief Program (TARP) into the major U.S. banks have hastened their recovery. Solid banks such as Wells Fargo & Co. (WFC), and PNC Financial Services (PNC) are likely to do quite well, gaining market share at the expense of their weaker brethren.

Indeed, Wells and PNC each completed major buyout deals right as 2008 came to a close.

This year, however, will be the one in which banks that have truly done a poor job will be separated out from those who merely made the obvious mistakes of the boom and just need time and some extra capital to work through their problems.

Citigroup, for example, was at the beginning of 2008 a pretty obvious example of financial-sector “roadkill.” A messy conglomerate of banking, investment banking and insurance that had been put together but never properly integrated, Citi had been at the forefront of every major financial disaster in the last 30 years and was not about to miss this one. The fact is that only weeks after receiving a $25 billion capital injection from the TARP, Citi was back in trouble again, this time requiring not only more capital, but a $300 billion guarantee of its liabilities. That’s a pretty good indicator that in a free market, Citi would have slid into corporate bankruptcy and liquidation.

Sign up below… and we’ll send you a new investment report for free: “Credit Crisis Report.”

Obviously, if the government chooses to keep Citi afloat, U.S. taxpayers, as a group, are (just) rich enough to make that happen. But a sensible government will eventually realize that these expensive rescues are pointless. The financial services business – once an economic mainstay – is declining in importance in the U.S. economy, and is probably half its relative size compared to its historic levels from the 1970s. In such an environment, capacity needs to be lost and Citi is the capacity most obviously surplus.

If Citi is propped up by the taxpayer, some other bank may be forced into bankruptcy, instead: My bet would be Bank of America, which made a very foolish acquisition in Countrywide Financial Corp., at the beginning of 2008 and a very dangerous one (because of its size and over-leverage) in Merrill Lynch right at the end of the year.

Countrywide was an enthusiastic participant in the worst excesses of the housing bubble, and hence will have a correspondingly large share of its detritus, while Merrill Lynch itself made what turned out to be a major misstep when it bought a major subprime mortgage lender, First Franklin, at the absolute peak of the bubble in 2006. Merrill had actually prided itself on its aggression in the housing finance business, but ended up having to shut down portions of First Franklin.

Aside from financial services, 2008’s major bailout was in the automobile sector. As is well known, all three major U.S. automakers – General Motors Corp. (GM), Ford Motor Co. (F) and Chrysler LLC – are in financial trouble and could be pushed over the edge by a couple of bad quarters. Given that the government would hate to see a major U.S. manufacturing sector disappear – especially one with the high profile that the car business has – and that the sums of money involved are smaller than in the banking business, I would not expect the automobile companies to be liquidated.

General Motors has world-class engineering and research capabilities that remain of huge value, and is becoming a bigger player in Asia, while Ford is in better financial shape than its competitors and also has good international operations and sufficient scale for its current focused strategy. On the other hand, it’s clear that both companies need to get out from under their past pension obligations, as well as their United Auto Workers Union (UAW) contracts, in order to compete against lower-cost competitors, both internationally and domestically (where a lot of the foreign carmakers now manufacture).

So, either a UAW agreement combined with a government assumption of most pension and healthcare obligations or a Chapter 11 filing (which would void the UAW and pension contracts) is needed. My bet would be on a “prepackaged” Chapter 11 filing – not a disaster for the companies, but I’d still avoid the shares.

As for Chrysler, it is too small to compete properly, has no international presence, and is owned by an overstretched private equity outfit. So hasta la vista, Chrysler!

Another area that’s seen its share of bankruptcies is retailing: Circuit City Stores Inc. (OTC: CCTYQ), Linens n’ Things Inc., Mervyn’s LLC and Sharper Image Corp. (OTC: SHRPQ) were among the biggest names to file in 2008.

That’s not surprising: Consumer spending is down – even in nominal terms – and needs to fall further, as the U.S. consumer rebuilds his savings rate from 2007’s pathetic 0.7% to the 6% to 8% range that was more the norm in the pre-bubble years. The recession will inevitably push more retail chains over the edge, with the highest casualty rate being among high-end and specialty retailers: Saks Inc. (SKS), for example, is taking losses and could be in trouble.

At the bottom end, as a recent Money Morning “Buy, Sell or Hold” feature detailed, Wal-Mart Stores Inc. (WMT) will probably continue to do well as middle class consumers find their budgets pinched and decide to restrict their spending to the land of “everyday low prices.”

If the recession is even longer and deeper than it’s already been, two other victims of middle-class spending cutbacks could be Target Corp. (TGT), which lacks Wal-Mart’s purchasing ability and whose prices are significantly higher than Wal-Mart’s, and The Home Depot Inc. (HD), which over-expanded during the housing boom, replacing traditional hardware stores, and which lacks the service capability to facilitate recession-resistant D-I-Y (do-it yourself) projects.

Producers of luxury goods, as well as retailers, may find themselves in trouble.

Just this Monday, china-maker Waterford Wedgwood PLC, filed for bankruptcy. The Dublin-based company, with more than 200 years of history, was a victim of social change and the move to less formality as much as it was to the global recession.

Like high-end retailers, luxury-goods producers will suffer from a massive decline in their customers’ purchasing power, as Wall Street bonuses disappear and redundancies soar, Middle Eastern oil sheiks cut back amid declining oil prices and the Russian mafia is forced to ask Prime Minister Vladimir Putin for bailouts. Many luxury goods producers are quite small and private, so their disappearance will not affect investors, but even such a giant as LVMH Moet Hennessey Louis Vuitton (OTC: LVMHF) will not find itself immune to the global downturn, and may be in trouble if that financial malaise remains in place for a long stretch.

It’s a rough tough world out there. As investors, corporate bankruptcy should be our No. 1 risk concern in 2009.

Source: Corporate Bankruptcies Will be a Key Investor Concern in the New Year

U.S. Federal Reserve Chairman Ben S. Bernanke didn’t use the “S” word – stagflation – but he might as well have. On Friday, the U.S. central bank chief said that the financial crisis that has hammered the U.S. market is combining with rising inflation to eviscerate American economy. Together, the two forces are making it extremely difficult for the Fed to restore economic stability in the U.S. market.

Bernanke apparently welcomed the recent drop-off in the prices of oil and other key commodities – and says that inflationary pressures will moderate over the next year and a half, but also cautioned that the current inflation outlook remains highly uncertain.

The upshot: The Fed will monitor the economic situation closely and will “act as necessary” to make sure that inflation doesn’t get out of hand. These dueling cross-currents – a sputtering economy and racing prices – is stagflation, the potentially ruinous manifestation that was once thought to be a theory only, meaning it couldn’t possibly show up in real life. That changed in the 1970s, when soaring energy costs and a collapsing U.S. global competitiveness combined to send the American economy into a tailspin. When the inflation rate peaked at 13.5% in 1981, then-Fed Chairman Paul A. Volcker had to put short-term interest rates up to more than 20% to finally break inflation’s back.

Let’s hope that’s not happening again.

With the afore-mentioned crosscurrents, most economists believe that Fed policymakers will leave short-term rates unchanged when they next meet Sept. 16 – if not for the rest of the year.

Unfortunately, the latest wholesale prices report is a cause for concern, and certainly didn’t put a stop to the recent inflationary fears. In July, the Producer Price Index (PPI) skyrocketed at its fastest rate in nearly 30 years, far exceeding most economists’ forecasts.  While some are keeping a “wait-until-next-month” attitude (when the lower energy prices will be reflected in the numbers), others point to the core data (which excludes the volatile food-and-energy component) as proof that inflation is here to stay – regardless of the shift in energy prices.  Core wholesale prices suffered the largest monthly increase since November 2006 as other sectors clearly have been impacted by the rise in commodities.

At week’s end, however, Bernanke seemed to be reveal that he is most concerned about the sluggish economy; he made his case for the current level of Fed Funds rate of 2.00% by projecting that inflationary “pressures should ease in the coming months as commodity prices fall and the economy slows.”

Despite the recent reprieve from record energy prices (and Bernanke’s comments notwithstanding), inflation definitely should remain high on the Fed’s radar screen (and Americans will still feel the pinch in their pocketbooks).  While some analysts expect food and energy prices to lead to lower overall inflation gauges (Consumer Price Index, PPI) in the months to come, the recent core numbers reveal that businesses and consumers will continue to be impacted by price pressures.

The upcoming release of the minutes from last month’s Fed policymaking (Federal Open Market Committee, or FOMC) meeting will delve a bit into the mindset of the policymakers as they continue to face the dual economic threats of sluggish economy vs. inflation.  On that note, the revised second quarter gross domestic product (GDP) estimate will be released and investors are hoping for an upward revision from the 1.9% reported in July.

Most experts had been counting on those tax rebates contributing more to the domestic economic growth.  Confidence and personal income/spending data will help dictate just how active the consumer will be in the months to come.  Retailers (discounter and luxury stores alike) will surely be watching to learn whether they can expect any positive news in time for the holidays.  Finally, two one-time industry leaders, Dell Inc. (DELL) and Sears Holdings Corp. (SHLD), report earnings, though such announcements do not carry the luster they once did.

Market Matters

Market/Index	Previous Week (08/15/08)	Current Week (08/22/08)	YTD Change
Dow Jones Industrial	11,659.90	11,628.06	-12.34%
NASDAQ	2,452.52	2,414.71	-8.96%
S&P 500	1,298.20	1,292.20	-12.00%
Russell 2000	753.37	737.60	-3.71%
Fed Funds	2.00%	2.00%	-225 bps
10 yr Treasury (Yield)	3.85%	3.87%	-17 bps

The latest business headlines are coming to us straight from China – the land that exports much of the world’s toys and other manufactured products and imports significant oil, natural gas and other commodities (greatly contributing to the prior surges in commodities-related prices). With Michael Phelps becoming an overnight hero at the Beijing Summer Olympics, a new corporate bidding war may soon begin as the record medalist prepares to be transformed into the next global marketing sensation (Whatever happened to just being featured on the cover of a Wheaties cereal box – you know, “the breakfast of champions?”).

Phelps currently maintains a contract with swimwear company, Speedo [The Warnaco Group Inc. (WRC)], and will collect a cool $1 million bonus for his gold medal accomplishments.  Enter Nike Inc. (NIKE), the sports apparel giant, with a limited swimwear presence.  Analysts project that Phelps could mean $50 million and a huge new market for Nike; the company may come calling with a blank check (Can you say Tiger Woods?  Michael Jordan?).

But here’s the issue as these companies prepare their bids and potentially increase their ad budgets during a period of economic uncertainty.  While Tiger and “MJ” participate(d) in sports that graced TV screens constantly, Phelps will drift into virtual athletic oblivion until London 2012.  Good luck, Michael.  Thanks for making us forget the global financial crisis – even if only for a couple of short days.

Speaking of the global financial crisis… just when it seemed that investors once again found it safe to hold Freddie Mac (FRE) and Fannie Mae (FNM) securities, a negative Barron’s article spooked shareholders that their stock prices were heading to zero amid an imminent government bailout.  Other analysts believed that full-fledged nationalization of the two government sponsored enterprises remains unlikely, and said that major loans from the U.S. Federal Reserve would seem the more logical path should capital infusions be needed.

Meanwhile, the respective stocks plunged to 18-year lows.  On the “lighter” side of the financial news, Goldman Sachs Group Inc. (GS), Merrill Lynch & Co. Inc. (MER), and Deutsche Bank AG (DB) joined UBS AG (UBS), Citigroup Inc. (C), JPMorgan Chase & Co. (JPM), and Morgan Stanley (MS) in reaching settlements with New York Attorney General Andrew Cuomo (doing his best pre-scandal Elliot Spitzer imitation) over past sales of risky securities.  On an even more positive note, analysts at JPMorgan stated that the next two years would be more favorable for financial firms than for energy companies  (Anyone interested in a Lehman Brothers Holdings Inc. (LEH) hostile takeover?).  In earnings news, retailers Home Depot Inc. (HD), Target Corp. (TGT), Saks Inc. (SKS), and Staples Inc. (SPLS) each posted worse-than-expected quarters, revealing that consumers are steering clear of just about every type of store these days.  Techs, however, got a boost as Hewlett-Packard Co. (HPQ) reported surprisingly strong results.

As the week began, the Dow Jones Industrial Average plummeted more than 300 points in two days as the Freddie/Fannie scare resurfaced.  Fortunately, the eternal optimists pointed to the light volume, which often results in exaggerated price moves (either up or down).  With the summer winding down, traders and investors alike head to the Hamptons for some much-deserved R&R (at least, those who can still afford it).  Oil prices suffered through some excess volatility as traders (over)analyzed the growing tensions between Russia and the United States, the weekly inventory data, and threats of storms in the Gulf that could have disrupted production.  By week’s end, the major equity indexes had bounced back, but still ended in negative territory.

Economically Speaking

As inflation worries continue to escalate, housing continues to struggle, as July construction starts plunged to their lowest pace since March 1991 and new mortgage applications also declined to levels not seen in almost eight years.  On the bright side (if any really exists), residential sales in So-Cal (Southern California) climbed to a 16-month high as homebuyers and real estate investors (more likely, speculators) finally found some value in certain foreclosed properties.  The predictive index, leading economic indictors, fell far more than expected as the continued slump in building permits led the ongoing pessimism about future housing activity.

Well, at least, So-Cal may be on the mend?  Any other regions care to follow?

Source: Worrisome Stagflation Becomes More Real All the Time

On the other hand, threats of hurricanes in the Gulf of Mexico and geopolitical turmoil in Iraq, Turkey, Nigeria – and now the fireworks between Russia and Georgia – could spark a dramatic reversal in sentiment and renew fears of supply disruptions.

However, this week’s economic calendar contains the types of reports that will factor into the musings of Federal Reserve policymakers with regards to interest rates.

The report on the Consumer Price Index (CPI) for July – due out Thursday – gives economists another look into domestic price pressures, although the recent drop in energy prices will not yet be reflected in this data.  Then again, economists tend to focus only on so-called “core” inflation (which “excludes volatile food-and-energy prices,” anyway).

The July retail sales report gives us some additional insight into the consumer mindset, demonstrating that those tax rebates are virtually all gone. With gas prices on the decline, consumers should have a bit more available disposable income in the months ahead (though, again, the July numbers may not show any enhanced activity just yet).

Additional confirmation of the recent consumer cautiousness should come from the next round of earnings reports, which will feature reports from such retailers as Macy’s Inc. (M), J.C. Penney Co. Inc. (JCP), Nordstrom Inc. (JWN), and Wal-Mart Stores Inc. (WMT).  Should the gas trend continue, consumers could emerge from hibernation just in time for the holiday shopping season… wishful thinking?

Market Matters

Let the games begin. As host of the 2008 Summer Olympic Games, Mainland China takes center stage and gets the chance to show the rest of the world that it has arrived as a global player and an economic superpower. Of course, no event should be more apolitical than the Olympics.  That is, until China banned some participants for their support of Darfur.  And before U.S. President George W. Bush criticized China’s poor record of human rights on the eve of the games. And before China deported a few activists who were demonstrating against certain national policies. (Probably nothing that a few gold medals won’t cure.)

Speaking of having politics cross over into the economy: Last week, Democratic presidential candidate Barack Obama publicly lobbied for the sale of 70 million barrels of oil from the U.S. strategic reserve and also claimed to now support new offshore drilling (if his tire gauge idea fails to prove an effective policy).  As the presidential-election campaigns accelerate into the home stretch, investors can expect plenty of promises (and flip-flopping) from both sides of the aisle.  (How do you feel about those Bush tax cuts this week, Senator McCain?)

So just where are investors to turn these days?  Freddie Mac (FRE) and Fannie Mae (FNM) returned to the headlines last week, as both reported significant losses – far in excess of Wall Street expectations.  (Weren’t those analysts following the news?)  Likewise, insurance giant American International Group Inc. (AIG) reported its third consecutive quarterly loss as its mortgage portfolio remained deeply under water.  Citigroup Inc. (C), Merrill Lynch & Co. Inc. (MER) and UBS AG (UBS) each reached multi-billion settlements with the New York state attorney general over certain high-risk securities that the firms will buy back from affected investors. Outside of financials, Cisco Systems Inc. (CSCO) – the subject of a recent “Buy, Sell or Hold” feature in Money Morning – provided a boost to techs by announcing better-than-expected profits; likewise, The Procter & Gamble Co. (PG) proved that consumer companies could still thrive, despite surging commodity prices.

Institutional funds have garnered additional interest as of late as investors seek out non-traditional asset classes to help compensate for the challenges of the markets.  In July, Hedge Fund Research Inc. reported that the return on a basket of 60 funds designed to reflect the industry as a whole declined by about 3%, the worst monthly showing in six years.  Tutor Investment Corp. will be spinning off its Raptor fund at year-end after bad calls on the energy sector caused ongoing losses for the past two years.  Private equity firm, Fortress Investment Group LLC (FIG), reported a larger-than-expected quarterly loss and has seen its share price drop about 40% since its IPO in early 2007.  Bear in mind, not all hedge funds and non-traditional assets are created equal; plenty of “winners” have emerged lately.

Anyone remember when oil touched $147 a barrel on July 11?  Has the bubble officially burst?  Energy continued its downward spiral as oil fell below $117 barrel, its lowest level since early May.  Rising inventories eased supply/demand concerns and renewed strength in the dollar also helped support domestic securities (thanks to the European Central Bank – see below).  Equity market volatility remained as investors tried to weigh the negative Freddie/Fannie reports against the positive energy trend (and the inactivity of Federal Reserve policymakers with regards to interest rates – also see below). Stocks alternatively soared, plunged, and soared again as the major indexes moved considerably higher by end of last week.

Then there are the ongoing Beijing Summer Olympic Games (which opened Friday), a reminder that every investor should have a China investment strategy.

[Editor’s Note: Please click here to read the first part of our two-part research report -"Why Every Investor Should Have a China Investment Strategy." The second part of that report will appear later this week.]

Perhaps that jubilant Olympic spirit is contagious?  So let the games continue: “USA…USA…USA…!”

Economically Speaking

They came, they debated, they analyzed, and they left – with no action taken. The “they” we refer to here are the members of the Federal Open Market Committee (FOMC), the Federal Reserve policymakers responsible for setting interest rates.

With dueling economic dilemmas impacting the country (slow growth vs. inflation), Federal Reserve Chairman Ben S. Bernanke and his band of central bank policymakers chose to leave the benchmark Federal Funds rate unchanged at 2.00% at their policymaking meeting last week.

While most Fed-watchers still expect the next interest-rate move to be to the upside, some believe such an action is unlikely before the end of this year as reduced consumer activity continues to spark talks of recession.  The recent decline in commodity prices helped the Fed stay on the sidelines, given that inflationary pressures are slightly less than before (at least, for the time being).  The European Central Bank (ECB) and Bank of England both left their key rates unchanged as they also weigh ongoing economic concerns in their countries against continued price pressures.  They prompted a surge in the dollar and took additional pressure off of the Fed, as well.

On the retail front, same store sales in July were lackluster at best as consumer held off on back-to-school purchases and focused on necessities such as food and household goods. (Apparently, last year’s No. 2 pencils and lunchboxes still will work fine.

Even the afore-mentioned Wal-Mart’s sales came in slightly below expectations while mall chains – the Limited Brands Inc. (LTD) and The Gap Inc. (GPS) – and luxury retailers such as Saks Inc. (SKS) all struggled as consumers no longer had those tax rebates to spend.  Moving to housing, the Federal Deposit Insurance Corp. (FDIC) reported that just under 1% of all prime (not subprime) loans originated in early 2007 were at least 90 days delinquent, meaning that the mortgage crisis still has a ways to go before being resolved (and additional write-downs may be on the way).  The weekly jobless claims data showed that more unemployed folks are seeking government benefits than at any time since March 2002.

Weekly Economic Calendar

Source: Federal Reserve Policymakers Will Hold the Line on Interest Rates – At Least for Now

• Wholesale prices rose 0.2% in April after seasonal adjustments, with food prices flat and energy prices falling, the Labor Department reported yesterday (Tuesday). The core PPI – which excludes food and energy prices – rose 0.4% in April, more than expected, MarketWatch reported.

• Target, the nation’s second-largest discount retailer said softer-than-expected sales and higher costs caused the profit fall 8% for the quarter that ended May 3, the Associated Press reported. Target reported a profit of $602 million, or 74 cents per share, in the three months ended May 3, down from $651 million, or 75 cents per share, during the same period last year. Revenue rose 5% to $14.8 billion.

• Chinese power plants are running out of coal, with less than a three-day supply in some areas, the Associated Press reported yesterday (Tuesday). It is the second time in three months that Chinese power plants have run short of coal, an unintended effect of government price controls to shield the public from rising global energy costs. About 32 power plants have already shut down due to lack of fuel, the State Electricity Regulatory Commission said in a report.

• Carl Icahn’s proxy gambit with Yahoo Inc. (YHOO) was given a boost yesterday, when Third Point LLC, a $5.7 billion hedge fund with more than 5 million Yahoo shares, announced its support for Icahn, Reuters reported, citing a source familiar with the matter. Last week, another hedge fund, Paulson & Co., announced its support of Icahn’s plan. Paulson & Co. owns 50 million shares in Yahoo.

• Oppenheimer & Co. analyst Meredith Whitney, who has famously slashed forecasts for leading U.S. banks in the past year, again cut her earnings outlook for several top banks, citing a “far from over” credit crisis, Reuters reported. She cut her outlooks for Citigroup Inc. (C) and JPMorgan Chase & Co. (JPM), Bank of America Corp. (BAC) and Wachovia Corp. (WB).

• Luxury department store operator Saks Inc. (SKS) announced yesterday (Tuesday) that its first-quarter net income increased 66% to $18.3 million, or 13 cents a share, from $11 million, or 7 cents a share, for the same period in the prior year. Analysts had expected earnings of 17 cents per share, causing Saks stock to shed 93 cents, a decline of over 6%, to close at $13.20.

• New Jersey-based Merck & Co. Inc. (MRK) has agreed to pay $58 million to 30 states to settle complaints that it made deceptive claims about its Vioxx-brand arthritis drug and painkiller. Attorneys claimed Merck played down the drug’s health risks in advertising. Shares dropped 28 cents yesterday (Tuesday) to close at $39.74.

• U.S. Federal Reserve Vice Chairman Donald Kohn indicated the Fed intends to pause in its rate-cutting campaign. “With the information now in hand, it is my judgment that monetary policy appears to be appropriately calibrated for now to promote both rising employment and moderating inflation over the medium term,” Kohn said yesterday (Tuesday), while speaking before a business group in New Orleans, MarketWatch reported.

Global Investing Roundups: Wednesday, May 21st, 2008