Permanent Value

Weekly Update: July 19- 24, 2010

Michael La Salle
July 23rd, 2010

Stocks Up as Euro-Bank Stress Test Results Come In

Stocks closed higher this week as earnings continue to surprise on the upside.  The S&P 500 gained 3.55% on the week as the Dow Jones Industrial Average gained 3.24%.  The biggest news of the week came Friday as the Committee of European Banking Supervisors announced the results of the evaluations they conducted on European banks.  The “stress tests” did not seem to be very “stressful” after only seven of 91 banks failed the test.

In economic news, home builders reported the weakest conditions since April 2009 on Monday as the housing market index fell to 14 in July, down two points from June.  Housing starts declined 5% in June to an annualized level of 549,000 starts, showing a total decline of nearly 20% over the last two months.  Existing home sales also dropped in June, but not as much as expected.  Analysts’ expected a drop to 5,260,000 annualized sales, while the actual drop was to an annualized 5,370,000 sales, a 5.1% decline for the month.  Jobless claims also disappointed this week as the new claims level jumped 37,000 to 464,000.  Economists’ estimates were set at 450,000.  

In earnings news, Halliburton Company beat analysts’ expectations as the Texas-based energy industry service provider posted earnings of 52 cents per share, 40.54% higher than the expected 37 cents per share.  Apple Inc. also surprised as the company reported earnings of $3.51 per share, estimates were set at $3.12 per share. 

What opportunities are ahead?

In October 2009 the United States Consumer Price Index switched over from a deflationary environment to inflationary environment.  Although the current rate of 2.3% is relatively low, recent government spending paired with massive current government deficits may make it necessary for the U.S. government to start printing money to pay back its creditors.

With the inevitability of the printing presses starting up in the future, there will also be some increasing downward pressure on the purchasing power of the U.S. Dollar.  There are many ways to hedge against this rise in inflation, including the most obvious choice, TIPS.

TIPS, or Treasury Inflation-Protected Securities, are treasury securities that are indexed to inflation in order to protect investors from the negative effects of inflation.  Since TIPS are backed by the U.S. government, they are considered an extremely low-risk investment.  All TIPS have a fixed interest rate attached to them, just like any other treasury bond, but as the Consumer Price Index rises, the par value, or the face value of the bond, also rises.

Since both the coupon payment and inflation-based adjustments to principal are federally taxable as ordinary income, buying Exchange Traded Funds, or ETFs, that hold TIPS is the best way to invest in the security.  The ETFs will also allow you diversify at a higher level than individual TIPS that you purchase directly from the government.

Although we are in a moderately low inflation environment currently, it is only a matter of time before the U.S. government will have to starting printing money, thus raising the rate of inflation.  Using TIPS can protect you from the loss of purchasing power in the future.

Market Returns

  This Week Year to Date Last Year Last 5 Years
S&P 500 3.55% -1.12% 12.94% -10.62%
Dow Jones Industrial Average 3.24% -0.03% 14.94% -2.13%

 

Next Week’s Economic Releases

July 26 – New Home Sales

July 27 – Consumer Confidence

July 29 – Jobless Claims

July 30 – Gross Domestic Product, Consumer Sentiment