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The U.S. Government Borrows $24 Billion

http://www.financialsense.com/Market/wrapup.htm

The borrowing demands of the U.S. government have put a tremendous amount of pressure on the financial markets. Today the U.S. Treasury sold $24 billion in 3-year Treasury Notes, which worked as a massive vacuum on the markets by sucking in all available capital. With the huge offering of 3-year notes, money came out of stocks and bonds across the board. According to CBS MarketWatch, “U.S. 3-year Treasury note sale sees lackluster demand. The bid-to-cover ratio, a measure of demand, came in at a weaker-than-expected 1.32 versus 1.96 at the last sale in May.” Investors were not exactly lined-up to buy treasuries, but there were at least enough buyers to absorb the debt, albeit at the expense of further declines in bonds of all maturities and a big acceleration in falling stock prices.

Now that the offering of three-year debt is out of the way, tomorrow our government will borrow an additional $18 billion in five-year notes and then on Thursday another $18 billion will be borrowed using 10-year treasury debt. This is big, big money that the government MUST borrow. If they are not able to borrow the money from investors, they must either do without, or effectively print the necessary money out of thin air. The alternative to borrowing the money would be for the government to simply cease operations, as they would have no money left in their checking account.

Today’s Markets

The Dow Jones Industrial Average fell 149 points today or 1.6% to close at 9,036, the S&P 500 was tagged for a loss of 17 points or 1.8%, and the Nasdaq Composite took the biggest hit by falling 40 points or 2.4% to close at 1,673. You can say goodbye to NASDAQ 1,700 for the time being since Cisco just reported hitting their expected numbers without breaking any records. Cisco’s net sales for the fourth quarter of fiscal 2003 were $4.7 billion, compared with $4.8 billion for the fourth quarter of fiscal 2002, a decrease of 2.6%. In the prior quarter Cisco’s sales were $4.6 billion, so the current quarter is still relatively flat. They are going to need stronger growth going forward if they plan to continue sporting a P/E ratio of 41. Cisco closed down 40 cents today at $18.86, but has fallen an additional 63 cents in after hours trading to $18.23.

Another story stock for the day is Costco Wholesale. The volume on Costco shares skyrocketed to over 56 million as the stock gapped-down at the open and continued falling $6.90 on the day for a close of 30.06, a loss of over 18%. Costco’s sales numbers were up 12% over the same period last year, but they couldn’t drive the higher sales to the bottom line. According to Richard Galanti, CFO, “Despite the satisfactory sales results, a combination of lower-than-planned gross margins, continuing escalation of costs associated with employee healthcare and workers’ compensation expenses, and increased initiatives to improve customer service and speed checkout at the front-end all led to reduced expectations for our fiscal fourth quarter results.”

These problems are not unique to Costco. Higher costs with little pricing power at retail have hurt the bottom line earnings. Guidance for near-term quarterly results has been reduced. This theme should hold true as we move through the second half of the year. I can tell you from first-hand experience that Costco is a buttoned-down company that runs their business with a very high degree of discipline. If they are having trouble controlling operating costs, I can assure you that it is consistent across Corporate America. Most U.S. corporations have been controlling costs by laying-off workers. In today’s headlines Challenger, Grey & Christmas, a Chicago based employment firm, said that employment reduction announcements rose 43% in July to 85,117 versus 59,715 announced layoffs in June. Keep taking away the consumers’ jobs and the second-half recovery is sure to be a flop.

Energy Moves Higher

One of the biggest contributing factors to higher costs that are reducing companies’ earnings is the rise in energy prices. Today crude oil was up another 38 cents to close at $32.22 per barrel, unleaded gas was up almost 3% on inventory concerns, and natural gas added 6.5 cents today to close at $4.695 per BTU. The bombings in Indonesia added to concerns over U.S. oil imports. Again, as we move through the second half of the year let’s watch for a recovery in corporate earnings. Without earnings, we are in for a nasty decline this fall…or are the ides of October coming early this year?

Back To What Matters

The only thing that matters this week is the selling of the government debt. Treasury prices have been plummeting, and with all of the additional supply this week, prices could continue to decline. The second factor that hurt bonds today was the release of the Service Sector Index by the Institute for Supply Management. The index of non-manufacturing businesses had a reading of 60.6 in June and was expected to decline to a reading of 58 when the surprise number came in today at 65.1. This is the highest level for the index since it began back in July of 1997. Also note that the service sector of our economy represents 85% of our total economy. So we get the highest reading in six years for 85% of our economy, and the stock market goes down 2% on the good news.

What matters is the selling of the debt. That is it. Everything else revolves around the fact that our government can not continue operating without borrowing more money. Once the money is borrowed it will surely be spent right into the economy, otherwise the economy would be in contraction. One of the big problems is that the money will be spent on implements of war (i.e., bombs and bullets) that won’t add a thing to your quality of life, or even add earnings to the companies that you own in your portfolio. Yes, the borrowed money will show up in the GDP numbers which will depict a growing economy, but the growth is not real growth to build upon, it is growth by temporary government spending via massive borrowing.

It comes as no surprise to me that stocks are taking a hit just when the economy is supposedly improving. It’s easy for the Wall Street Spinsters to say that bond prices are getting killed because the economy is improving, but where is the follow-through from stocks? When the government needs to borrow $60 billion in one week, everything else must be pushed to the back burner until the debt is sold. Last Friday I stated that the markets were being conditioned to buy Treasury paper. Bonds were already oversold (we thought) to make the yields more attractive for this weeks’ auction, and stocks have gotten ahead of themselves, so money could easily come out of stocks to buy the Treasury paper. The coverage on the sale of the 3-year notes was thin today. We will just have to watch and see how things go tomorrow and Thursday as they auction the rest of the debt paper.

I have increased my short positions for the overall stock market and am patiently waiting to find the near-term bottom for bonds to play the bounce. Precious metals are in a holding pattern until the debt is sold. In fact, gold investors were put on notice last Friday in the late-day take-down right before the close. Silver investors got a hand slap today with silver losing ground, but the stocks held up well. I read the metal bashing as someone saying, "Don't even think of buying gold and silver until all the debt is sold. We can't let the metals rise because it will show weakness in our paper." Everyone will know the precious metals bull market is real when the price of the metals goes up in all currencies. With the current stresses on the global monetary system, precious metals are a very nice way to feel some security in the preservation of wealth.

© 2003 Mike Hartman
August 5, 2003