Connecting the Dots

By: Tony Sagami | Sat, Oct 8, 2005
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Another rate hike warnings from a Fed head
Mortgage rates hit six-month high
A.C. More reports 6.2% drop in customer traffic
Foot traffic and sales fall at Ann Taylor
Same-store lump at Bon-Ton
Inflation knows no borders

The bulls were unable to convert what should have been very, very positive news into any stock market hay. What I'm talking about the sharp drop in oil, which dropped to $61.36 today.

The Dow Jones was up by 52 points at one time in the morning, but finished the day with a 30 point loss. That type of failing rally is often a good sign that the market has hit an exhaustion phase and has put in a top.

The fourth quarter has barely started and the markets are already in trouble -- the Dow, S&P and Nasdaq have respectively lost 2.7%, 3.1%, and 3.2%.

If Q3 earnings come in as weak as I believe they will, those losses will look like peanuts in a few more weeks.

Another rate hike warnings from a Fed head. Thomas Hoenig, president of the Kansas City Federal Reserve Bank, warned an audience in Capser, Wyoming that inflationary pressures are building too fast.

"That means we have resource pressures continuing in the economy. Any one of these items by themselves I think you could deal with and explain ... but now we have them coming together at the same time from a period of time in which monetary policy had been accommodative."

"So there is this issue of inflation, not that we have it because 2.2 percent core inflation is a modest level, but we don't want it to get higher than that because then we start changing the inflationary psychology of the economy and we do not want to see that."

These comments are on the heels of equally hawkish comments of other Fed members.

"To keep cyclical price pressures and any transitory spike in energy prices from permanently disrupting the price environment, the Fed will have to continue shifting monetary policy from its current somewhat accommodative stance to a more neutral one." Philadelphia Fed Bank President Anthony Santomero.

"The inflation rate is near the upper end of the Fed's tolerance zone, and it shows little inclination to go in the other direction." Dallas Fed Bank President Richard Fisher

It is clear that Alan Greenspan and his Fed buddies are convinced that 11 interest rate hikes have not been enough. How much higher will the Fed raise interest rates? 25 basis points? 50? 100? More?

Nobody knows for sure, but rates are heading higher.

Speaking of higher interest rates...

Mortgage rates hit six-month high. According to Freddie Mac, the average rate on a 30-year fixed mortgage rose to 5.98% last week - the highest rate in six months.

No surprise -- applications for mortgages to purchase homes dropped 1.9%.

I guess if the Wall Street crowd isn't worried about $60 oil, it shouldn't be worried about the consequences of 11 interest rate hikes on mortgage rates either.

You and I know better. At some point, the scales will tip and buying power financed by cheap money will dry up.

A.C. More reports 6.2% drop in customer traffic. A.C. Moore Arts & Crafts (Nasdaq:ACMR) is a specialty retailer of arts and craft supplies: paints, brushes, scrapbooking supplies, stencils, yarn, cake making supplies, felt, glitter, doll making, silk and dried flowers, potpourri, candle making supplies, etc.

Apparently, business isn't so hot at ACMR. I say that because ACMR warned that instead of making 5 cents of a share of Q3 profits, it now expects to lose 10-12 cents.

Wall Street was expecting $123 million of sales, but ACMR thinks it will be lucky to hit $115 million. Talk about a turnaround for the worse!

What's the problem?

"The third quarter was a disappointment for the Company as customer traffic dropped 6.2% and was below our expectations due to several factors including rising gasoline prices."

People that run a retail business understand that high gas prices are sucking consumer's wallets dry. It is just the pinstripe crowd on Wall Street that doesn't get it. That 6.2% drop in customer traffic is simply the end result of some very weak consumer demand.

ACMR, of course, gets it and realizes that things aren't going to get better any time soon.

"Significant uncertainty in the current economic environment and how the consumer will react during the fourth quarter."

That is a not-so-subtle hint that Q4 is going to stink too.

And no, the Wall Street crowd cannot blame Hurricane Katrina because ACMR operates in the eastern U.S. -- not the gulf coast.

Foot traffic and sales fall at Ann Taylor. Ann Taylor reported that its same-store sales fell by 2.7% in September.

The Wall Street crowd was way, way off base with their expectations of 1.6% increase in same-store sales. Gee, what a surprise (sarcasm).

Ann Taylor suffered the same ailment that A.C. Moore Arts & Crafts did: lousy foot traffic.

"Overall results for the month were negatively affected by a low double-digit decrease in traffic."

Low double-digit? We're talking about a major drop in consumer activity here.

There is one new piece of information in Ann Taylor's news that we need to pay attention to.

Up until now, the high-end retailers -- like Coach and Tiffanys -- have been holding up very well while the low-end retailers have been singing the loudest blues.

Since Ann Taylor caters to a more mature, affluent customer base, their horrendous same-store sales report tells me that the retail blues are climbing up the income ladder.

Same-store lump at Bon-Ton. Bon-Ton Stores operates 141 department stores across the country but is suffering from the same problems as Ann Taylor and A.C. Moore -- slumping same-store sales.

For the month of September, Bon-Ton reported a 7.8% drop in September same-store sales. That's an awfully big drop in demand.

"Consumer spending was impacted by several issues during September: increased gas prices, hurricanes Katrina and Rita and predictions of higher heating costs."

The list of retailers reporting a drop in same-store sales goes on. Jo-Ann Stores, New York & Co., Stein Mart, and Talbots all admitted to suffering from the same sales slowdown.

I wonder how many of retailers complaining about high energy prices it will take before the Wall Street knuckleheads start taking down their Q4 expectations?

I can't tell you when that will happen, but when it does, you won't want to be holding any retail stocks.

Inflation knows no borders. The U.S. isn't the only country struggling with the inflationary pressures that come with $60 oil.

Jean-Claude Trichet, the president of the European Central Bank, made some very hawkish statements about inflation.

"Strong vigilance with regard to upside risks to price stability is warranted. It is essential that the increase in the current inflation rate does not translate into higher underlying inflationary pressures in the euro area."

In other words, the ECB is ready and very willing to raise interest rates fast/high enough to keep inflation in check.

It would be a mistake to think rising interest rates in European won't affect you. Increases in foreign interest rates will put pressure on the U.S. dollar -- additional pressure on top of our unmanageable budget and trade deficits.

When foreign investors lose their confidence in dollar-denominated assets...the selling of U.S. stocks and U.S. bonds will be as deadly as a tidal wave.


Tony Sagami

Author: Tony Sagami

Tony Sagami
Harvest Advisors.

Tony Sagami

Tony Sagami is the owner and founder of Harvest Advisors, an investment research and money management company. Sagami has been managing money for more than 20 years and is one of the early pioneers in the application of technical and quantitative analysis to mutual funds and stocks.

Tony is a man that wears several hats. In addition to Harvest Advisors, he has launched several successful technology companies. Tony is the owner of Monocle Systems, a popular investment analytical software program that has been used by thousands of professional money managers and sophisticated individual investors. Tony is also co-owner of AdvisorSquare, one of the largest web design and hosting companies in the world.

Tony is a frequently quoted expert, appreciated for his frank and unconventional view. Tony has appeared in publications such as the Wall Street Jouranl, Barrons, Kiplingers, Smart Money, Business Week, New York Times, Washington Post, Investors Business Daily, Bloomberg, Financial Planning Times, Mutual Funds Magazine, Chicago Tribune, LA Times, and many others.

A graduate of the University of Washington, Tony enjoys coaching youth sports, serving his community as an active Rotarian, and exploring the all the beauty that Montana has to offer. Tony is a Paul Harris Fellow, an Eagle Scout, and married to his first-and-only wife and father of 4 wonderful kids.

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