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Five Things You Need to Know: America Eats the Speculators


"A year ago there was ground for concern that a too rapid rise in the prices of some commodities was encouraging a speculative boom," the President said.


Kevin Depew's Five Things You Need to Know to stay ahead of the pack on Wall Street:

1. America Eats the Speculators

With crude oil now above $130 a barrel and food prices continuing to rise, it was only a matter of time before Washington figured out a way to get involved. Yesterday the Senate Homeland Security and Governmental Affairs committee heard testimony on how speculators, hedge funds and institutional investors may be contributing to soaring energy and food prices.

Senator Joe Lieberman, (ID - CT) kicked the hearings off with a statement expressing concern over the influx of speculators into commodities markets. "This influx of institutional investors and hedge funds into relatively small markets for goods such as rice and corn raises important questions about the ability of the markets to absorb these new investors without distorting or undermining fundamental supply and demand forces."

Among those testifying was Michael Masters, Managing Member and Portfolio Manager of Masters Capital Management, LLC. "Index speculators' trading strategies amount to virtual hoarding via the commodities futures markets," Masters said. "Institutional investors are buying up essential items that exist in limited quantities for the sole purpose of reaping speculative profits," he said.

That's not exactly true. What institutional investors are buying up are futures contracts representing potential delivery of commodities. That's not exactly the same as hoarding oil and corn. Removing speculators from commodities markets doesn't increase the amount of oil or corn in the ground by one bushel or barrel.

"A year ago there was ground for concern that a too rapid rise in the prices of some commodities was encouraging a speculative boom," the President said. "During the past six months, on the other hand, the general price level and industrial activity have been declining. Government policy must be directed to reversing this deflationary trend." Wait, the President said that? Yes, he did. Back in 1938.

See President Roosevelt and Commodities Prices, Time Magazine, February 28, 1938 for more on how reining in commodities prices, punishing speculators and managing the economy works in reality.

2. Tax Rebates Meet Necessities

This morning we took a listen to the Capital One (COF) presentation at the Lehman Brothers Financial Services Conference. A key question for Gary Perlin, Chief Financial Officer and Executive Vice President of COF, was how big of an impact is the company expecting from the tax rebate checks?

According to Perlin, not much. "People are definitely moving a lot of their expenditures from luxury to necessity; my guess is that they will probably be using those rebate checks for the same purposes, especially when they have to spend $60 or $70 to fill up their tax," he said.

Perlin added that while COF expects to see some balance growth, it will not be in the consumer discretionary area, but coming from areas where necessities have increased in price.

3. Who Benefits From Consumers Trading Down?

Speaking of necessities, who benefits from consumers focusing on reducing the costs of necessities and trading down? Apparently BJ's Wholesale (BJ). This morning the company reported both first quarter store traffic and average transaction size increased 3%. The traffic increase is the company's largest traffic booth since 2004.

The results were largely driven by increases in food an perishables. Departments with strong first quarter sales included juices, coffee, frozen, milk, dairy, produce, fresh meat, paper products and health and beauty aids. Departments with weaker first quarter sales included cigarettes, prerecorded video, tires, sporting goods, apparel, jewelry, storage, furniture, and summer seasonal goods.

Frank D. Forward, BJ's Wholesale Executive Vice President and Chief Financial Officer, said the company is seeing evidence of tradedowns by consumers. "I would say that we have seen, especially categories with a significant inflation, that customers trading down within the category sometimes," Forward said. "So, I guess we are seeing a trade down and the decrease in quality."

Interestingly, however, the BJ's Wholesale story is not entirely about inflation, a point we have been desperate to try and emphasize here in Five Things; our contention being that inflation in necessitates will ultimately breed consumer cutbacks and demand reduction. Herbert Zarkin, BJ's Wholesale Chairman and CEO, said, "We actually see deflation in some categories, price inflation and others." It's the inflation in the "others" category that will exacerbate the deflation in the "some."

4. Daily Counterintuitive Datapoint: Credit Card Delinquencies Lead Unemployment, Not Vice Versa

Circling back to the Capital One (COF) presentation at the Lehman Brothers Financial Services Conference for a moment, we noticed an interesting slide from the materials COF presented showing the relationship between credit card delinquencies and unemployment. Now, intuitively, we would think that rising unemployment would certainly restrain credit card payments, worsening delinquencies. But, according to Capital One, we would be wrong.

In the chart below, COF tracked industry US credit card delinquency rates against the unemployment rate. Over the course of the last 20 years there are only two recessionary inputs, 1990-91 and 2001-2002, but as you can see from the chart, credit card delinquency rates tend to be a leading indicator of unemployment rather than visa versa.

According to Capital One CFO Gary Perlin, loss rates peak in the credit card space before unemployment peaks. "I wish I could give you a very deep insight into why this is," Perlin said, "I think the answer is probably that people don't necessarily have to wait to receive their unemployment notice to know that their employer is in trouble that they may need to be retrenching."

Answering the inevitable question about where exactly we are in the current cycle, Perlin noted that once again loss rates in COF's current business moved up well before degradation in the employment market. "What I don't know is whether or not the loss rates that we have seen to-date are simply as far as we go and unemployment will catch up with us or whether we are going to keep seeing higher losses as the expectation of a
degradation in the labor market continues," he said.

5. Bear Stearns Fire Sale

We saw in the New York Post where Bear Stearns (BSC) is holding a fire sale. No, not a fire sale of collateralized debt obligations backed by subprime mortgages (JP Morgan (JPM) and the Federal Reserve bought all of those). It's a fire sale of... T-Shirts. Seriously.

According to the Post, Bear Stearns' remaining staffers lined up in the second floor cafeteria of the firm's midtown offices to snatch up t-shirts, hats and umbrellas featuring the soon-to-be vanished firm's logo.

Bear Stearns' baseball caps were being sold for $8.60, golf shirts ranged from $15 to $25 and umbrellas fetched $7, the Post said. Another batch of merchandise will be sold today.

But look, if you can't make it to midtown for a Bear Stearns t-shirt and don't want to rummage through Ebay for overpriced memorabilia, we have a version below you can pick up via Zazzle:

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