Economic indicators indicating that higher energy and food prices might be seeping into other parts of the economy, coupled with continued concerns about the high price of oil, continue to hold back stock market performance. Prices for crude continue to soar past the $130/barrel level and have more than doubled over the past year. In addition, gas prices are setting record highs on a daily basis, just in time for Memorial Day and the start of the summer driving season.
 
Although the Labor Department reports on consumer prices showed a surprisingly modest 0.2 percent uptick in April, the producer price report showed that prices outside of food and energy rose 0.4 percent, double what analysts had expected. This increase puts inflation (outside of food and energy) at 3 percent over the past 12 months - the fastest increase for a 12-month period since late 1991. Arguably, this statistic signals that the higher price of food and energy may be beginning to influence other sectors of the economy.

On Wednesday, the Fed released new forecasts, lowering its growth expectations for the year while raising projections for inflation and unemployment. According to the minutes released from the April meeting, the most recent rate cut was a “close call”, an indication that the Fed will not lower rates in the near future. The Fed members who voted against the latest rate cut argued that the cuts were driving inflation up and doing more harm than good to the economy. In addition, the Federal Reserve Bank of Chicago recently issued a report that showed U.S. economic activity weakened further in April and reached its lowest level since the 2001 recession.

In a rare bit of good news, construction of new homes increased in April by the biggest percentage in two years. However, much of the growth came from the apartment housing sector, a more volatile sector than single-family homes. Apartment construction growing by 36 percent in April offset the single-family sector’s decline of 1.7 percent, yielding a net increase in overall construction.

The surge in crude oil prices shows no sign of abatement, with prices surging past the $130/barrel level on Wednesday. This increase was in part due to continued concerns over supply, which were exacerbated by the Energy Information Administration’s weekly inventory report. According to a survey from Platts, an energy research firm, analysts expected crude oil stocks to be up 900,000 barrels, gasoline stocks to be up 500,000 barrels, and distillates stocks to be up 1.45 million barrels. In reality, report data showed a decrease in crude oil stocks of 5.4 million barrels, gasoline stocks down by 800,000 barrels and distillate stocks up by only 700,000 barrels.

Deal Overview

Strategic buyers appear to be taking advantage of the decline in large private equity buyouts, with several large companies bidding against one another to win deals in the market. Russian metals and mining company OAO Severstal offered Tuesday to buy Esmark Inc. for $17 per share in cash, meeting the price offered by India’s Essar Steel Holdings. Both deals called for approximately $670 million in cash and the assumption of $400 million in debt, putting the total value of either deal at $1.1 billion. The Essar deal was backed by management and the board, but the United Steelworkers union late last week said it would oppose the deal and contended that Esmark accepted the deal without giving the USW adequate notice or a chance to put forth an alternative. The union's contract, which expires September 1, gives it the right to reject any deal that changes control of the company.

Also, the hostile takeover of office supplies distributor Corporate Express NV launched by Staples Inc. took an interesting turn, with Corporate Express announcing plans to instead buy French peer Lyreco SAS for about $2.7 billion in cash and shares. Corporate Express's board rejected a $2.47 billion takeover offer from Staples last week, saying it undervalued the company. If approved by shareholders and regulators, a Corporate Express-Lyreco combination would create a sizable international competitor to Massachusetts-based Staples. Corporate Express-Lyreco would be larger than Staples in business-to-business sales in the U.S., Europe and Asia.

On the buyout front, the Clear Channel deal appears to have finally been resolved with Bain and THL agreeing to a deal for $36 per share, down from the revised $39.20, while paying a higher interest rate on the debt. This has increased speculation that the Bell Canada deal will be repriced from its current record price of $51.8 billion, with the New York Times reporting that the banks supporting the deal sent revised financing terms to the consortium of private equity sponsors.

Another factor driving the increasing popularity of stock buybacks is the strength of corporate balance sheets following several years of strong economic growth. In times when the returns on new investments are more uncertain, investors may push companies to use some of the excess cash directly for the benefit of the shareholders rather than have this wealth tied up on corporate balance sheets.