Where are Americans spending their rebate checks? Apparently Wal-Mart Stores, Inc. (NYSE: WMT) and Costco Wholesale Corporation (NASDAQ: COST). Both reported fantastic sales for May. Wal-Mart explicitly tied their success to the checks. "We're seeing some benefits from the stimulus checks," Wal-Mart Chief Executive Eduardo Castro-Wright said in a company press release. Wal-Mart same store sales were up 3.9% (4.4% if you include gas).

Costco sales were even better, up 5% from last year (7% if you count gas). Costco saw sales of $5.77 billion, up about $600 million. The theory is that people are turning to Wal-Mart and Costco because we're broke and because we're so freaked out by gas prices, we'd rather just drive to one big store. Nice theory, but Target Corporation (NYSE: TGT) is in the same business and saw sales drop 0.7%.

How many of us have spent our rebate checks at Wal-Mart and Costco? About 73% of Costco's stores are in the U.S. (The foreign stores got a big boost from the weak U.S. dollar). So, let's say very roughly 73% of Costco's $600 million sales increase was in the U.S. Or, Costco took in an extra $438 million thanks to the rebate checks. (Yeah, I know, the sales probably would've been up anyway, if only for inflation). At Wal-Mart domestic stores saw a $1.4 billion increase. Assuming we all spent our $600 in one place (just to make the math simpler), that would mean a little over 3 million of us (3,063,333) spent our rebated checks at Wal-Mart and Costco in May.

You've been hearing and reading all the bad news about the credit industry and all the nasty things that its difficulties might mean to you, but is anyone considering the positive outcome that this major reset of the American economy could mean in the long run? Being that I'm a cynical optimist (an oxymoron, I know), I have a perspective on this mess which many people might not be thinking about.

I've been telling you since late 2006 that we have entered a world economic shake down and that the biggest hindrance to further growth in the American economy is the fact that the balance sheets of American corporations are full. I cite the sudden spate of major acquisitions in pursuit of profit creation via consolidation as support for my opinion. As modern economics are conventionally structured, the only basis for economic health is steady growth. That makes the case for the necessity of this period of down slide only too palpable.

If we as a nation can financially hold it together for the next couple of years and swallow the huge bitter pill of a recession, when we come out on the other side of this mess we shall reap the incredible rewards of the "green economy" which is now in the process of being built. Today we are planting the seeds of America's next economic boom and I'm sorry to report that most of the rest of the world has mistakenly adopted our old patterns.

Historically, when the Fed has started cutting rates, investing in financial stocks has proven profitable for investors. Will the same hold true in today's easing cycle? Probably not.

The Bear Stearns (NYSE: BSC) model for its mortgage business might point to problems ahead for the financial industry in general. The financial services industry has done an outstanding job during the past twenty years developing new products and marketing them to institutions who specialize in buying these new instruments -- primarily hedge funds. With mortgage hedge funds, publicly traded vehicles such as mortgage REITs and other investors now shutting their doors to these products, who gets stuck with them? You guessed it! The investment firms and large commercial banks.

Now let's go to $300 billion of private equity debt that needs to be placed. Who is buying that up? While some institutions are, much of it is staying on the books of the investment firms and banks. Will funds be formed to invest in this debt? Yes, but it will take time.

In the 1980s, high-yield bonds often yielded 13% to 14%, substantially higher than the 10% to 11% yield called for in the recent pricing of Chrysler's debt.

However, the Chrysler debt might be dramatically more expensive than the higher yields of the 1980s. During the decade of Reaganomics, while inflation was coming down, it was still very high. Real GDP growth of 6% plus inflation of 8% brought nominal GDP to 14%. When compared to high-yield bonds of 13% to 14%, the cost of the debt was not too expensive.

In today's market, with real GDP growth approaching 3% and inflation at 2%, this translates into nominal GDP of 5%. With high-yield bond rates of 11%, it is roughly double nominal GDP growth. That is expensive debt.

This means real interest rates in the high-yield bond market are 8% to 9%, which might be too high for an economy that is more mature and has lower inflation. Many bond investors are saying high-yield rates are correcting back to a normal spread. However, when compared to inflation, real interest rates are very high.

The Fed's goal: get real interest rates lower. The first cut should come in September, followed by at least two more rate cuts by year end.

Allowing the yuan to float would slowdown China's too rapidly growing economy, says Chen Zhao, chief global strategist of the Bank Credit Analyst Research Group in Montreal. China's economic leaders have been unsuccessfully trying to slowdown growth in this emerging market, as GDP data has jumped to 11%, above the 9% targeted range.

While China officials have allowed the currency to appreciate versus the dollar, since the yuan is linked to the dollar, China's currency is still undervalued versus the euro and the yen by some 30% as the US dollar has weakened against these leading currencies since 2002. Since 1997, China's share of global exports has jumped from 3% to 9%.

Persistent currency undervaluation inevitably leads to an overheated economy as cheap exports bring in foreign reserves which increase the monetary base. Despite numerous actions to choke off growth, the Chinese stock market and economy continue to boom, with the stock market up 90% for the year and 200% from a year ago level. Real estate is also booming.

Zhao argues that the only solution is let the yuan appreciate considerably, not for American interest but for Chinese interest. This would slowdown exports and stop money supply growth.

The Chinese economy needs a serious shock to slowdown growth and control inflation. From an investors' perspective, avoid the Chinese stock market. It needs some tough monetary medicine to control this overheated economy.

The Fed chairman decided to side with global central bankers rather then direct his comments solely at the U.S. economy earlier this week, saying the central bank remains focused on inflation as "risks remain to the upside."

Ben Bernanke is in a tough spot. On the one hand, economic data suggests the US economy is slowing down, but there is scant anecdotal evidence to suggest this is actually happening. Virtually everywhere you go, the economy looks good, with most employers having trouble finding qualified employees and eateries and other social settings showing little, if any, signs of inactivity. This is despite a meaningful slowdown in the housing market.

Further, the Fed chairman has to decide if inflation is a U.S. or global problem as emerging markets make up more of the global economic pie. While economic data suggest the Fed could be close to dropping rates, very resilient emerging markets, such as China, cannot seem to get their economy to slow down.

What will the Fed do? Very hard call. Properly side with controlling global inflation. Inflation, or lack thereof, has been, for the most part, a global phenomenon. If China is unsuccessful at curbing its higher growth rate and building pricing pressures, it will hurt the economy of the entire world, not just China.

This is why the market got hit this week. Expect Bernanke to continue talking up the fight against inflation as long as emerging-market central bankers are still attempting to slow down growth. While this might cause some short-term pain, it will prove a positive for the long term, particularly for equities which like low inflation environments.

Data from the U.S. and Japan suggest economic activity is slowing for the more mature economies around the globe. U.S. retailers are coming in light on revenue -- and remember that close to 70% of U.S. GDP is consumer driven. However, emerging-market economies appear to be growing nicely, with China being of particular note, growing GDP 11.1% in the most recent quarter, above its 9% target rate.

China officials have been attempting to get growth back to its 9% GDP target for quite some time, so far without much success. And the economies of other commodity-focused counties continue to do well.

Is the Fed responsible for the world's economy or just that of the U.S.? This is a very difficult question to answer. However, the last time world leaders let broad-based inflation pick up, in the late sixties and early seventies, it culminated in the breakdown of the Bretton Woods agreement and the global economy went through decades of hell. Emerging markets were the most severely punished.

This is a serious issue the central bankers of the larger and more mature economies need to address. Is it worthwhile for the mature economies to approach a recession while emerging markets attempt to slowdown their economies? We will see. They must be discussing that issue right now.

A 25% price decline in home prices is still required to revert back to the mean, according to Tom McManus, chief investment strategist at B of A. McManus said in a conference call yesterday that when compared to rents and household income, a considerable adjustment in home prices is still required, even after the recent price weakness.

If that drop were to occur quickly, it could be very disruptive to the overall economy, but the more likely scenario is for the adjustment between home prices and their affordability to occur over a five-year period.

What was also scary was the relationship between housing prices and investors' buying momentum. Investors sentiment appears to be super high for these stocks despite the poor performance for this group. This compares with energy where the group has performed well, but investor sentiment remains very low. A bullish sign for energy, not for housing.

McManus's point: no need to bottom fish in housing yet.

Following our blog on the continued deterioration in the leading indicators for the economy, Ethan Allen Interiors Inc (NYSE: ETH), a very good indicator of economic activity, last night reduced its EPS estimate for this current quarter to 53c-56c, well below the expected 59c consensus.

Ethan Allen is one of the few companies that have positioned themselves to survive and possibly thrive when the Fed decides to fuel up the economy again. Management honesty in the way they evaluate their own performance translates into honestly on how they communicate to investors. Therefore, a good source for what is going on in the economy.

The furniture maker began warning of a slowdown very close to when the housing industry rolled over. It appeared the economy was moving along fine, but once again Ethan proved to be a good and correct data point on housing and subsequently the economy.

It is time to start using Ethan Allen as the indicator as to when the economy will bottom. If the stock does little to the downside today, it is most likely a sign the selling is done and the Fed will move to lower rates.

It is no coincidence the Fed changed its language last week from concerns about inflation picking up to a neutral stance on prices. From looking at the chart below, when the downward slope of the economic leading indicators has been this steep, it has meant a meaningful slowdown is on the horizon.

Mr. Bernanke is very aware of this chart. The question is how proactive he wants to be. Greenspan never would have stopped raising rates when Bernanke did -- a very bold move for the relatively new Fed Chairman. A bolder move would be to lower rates at the next meeting and forgo a recession.

Last week, commodity and company earnings sent some seriously mixed signals.

Gold, historically a pretty good indicator of excess money flowing through the economy, took off, jumping over $20 an ounce. Gold has been in a tight trading range the past year or so, a sign that Fed policy was correct by halting rate increases. However, it is tough to read what last week's rally was all about.

Housing data, conversely, an important component of the overall economy, was simply awful. Reports from the home improvement retailers -- Home Depot (NYSE: HD) and Lowe's (NYSE: LOW) -- were exceptionally weak, with same store sales down 5% to 11% depending upon the month you wanted to look at.

However, macro data such as employment and wage growth remain good, but employment is a lagging, not a leading, indicator.

With that said, in addition to gold, a lot of other commodities took off during the week.

In the tech world, semiconductors, one of the most hypersensitive economic indicators, fundamentals have been deteriorating since November 2006 and there is little evidence this market has bottomed.

Signals are too confusing to be comfortable with the market. Most indexes have had great rallies since the fall. It is time to take some money off of the table. There is little evidence that 1st quarter earnings will be that good.

In addition, another consideration is a seasonal factor. The Fed tends to add more money to the economy in the second half of the year and slows down money supply growth in the first half of the year. This is a reason why the market's performance tends to be weakest during the April through September time period and stronger from October through March.

These mixed signals tell me to start pruning your portfolio. We are in for a bumpy ride and it will be nice to have some cash on the sideline to do some buying when market volatility and investors' fear increases.

David Malpass of Bear Stearns wrote a great op-ed piece on how to interpret the trade deficit. The full article can be found on the Forbes Digital Rules blog.

Here are some some of his thoughts:

• The imbalance, the trade deficit and related capital inflow all link the faster-growing U.S. with other aging, slower-growing economies. They are a reflection of growth in the U.S., not weakness.
• Despite our trade deficit and other countries' trade surpluses, the U.S. economy has created 9.3 million new jobs since the 2001 recession, compared with 360,000 jobs in Japan and 1.1 million jobs in the European zone, excluding Spain.
• Speaking of Spain -- like the U.S., Spain (3.6 million new jobs) and the U.K. (1.3 million new jobs) also ran trade deficits and created jobs rapidly during these last five years.
  
• The recent upswing in the U.S. trade deficit partially reflects the shift in the demographics of the world's large economies. The under-60 population in the U.S. is expected to grow for at least 50 years, whereas the under-60 populations in Japan and Europe is already in a decline and China will also be in a decline within a decade.

We have blogged in the past on how the trade deficit has been misinterpreted by economic pundits for years. In my opinion, David Malpass is one economist who gets it right.

Some of you laughed when Sheldon Liber pointed to sales of art and crafts in Venice Beach, Calif., as a leading economic indicator -- and some of you (like me) thought it prescient. I couldn't help agreeing, as I'm dialed into the crafts scene here in Portland, Ore., and have watched a startling decline in artsy-fartsy sales since last fall.

Reading today's MarketBeat from The Wall Street Journal [subscription required], then, I found the latest kooky indicator: Bobby. More to the point, the sales of Bobby's grilled chickens. He owns and operates a lunch grill somewhere in the Great Lakes, and his business has fallen sharply, despite lowering his price-per-lunch plate from $7 to $6.25. Notably missing amongst his regulars: the blue-collar workers.

Blogger Jeff Matthews discovered Bobby, and he believes Bobby's chicken sales are an indicator. He writes, "Being in the Midwest, and being a half-dozen hours north of Detroit, what we have here is the real-life impact of those GM and Ford oops-we-make-gas-guzzlers-and gas-is-$3.00-a-gallon headlines, multiplied across dozens of factories and thousands of lives dependent on those companies and their gas guzzlers for work." Matthews believes we'll see the impact in GM, Ford, Toll Brothers, Centex Homes, Lowes, Home Depot.

I'm fascinated to see if these theories end up being correct. Could a slowdown be in the works for the fall?

Writing for Slate magazine, Daniel Gross has a history of making sweeping generalizations based on the fortunes of the latte. This week, he's analyzing the same reports we agonized over last week: that Starbucks same-store sales were falling, because (Howard Schulz said) customers were tired of waiting in line for frappuccinos. Gross' theory is an interesting one, and he has charts to back it up: he says that Starbucks, like Whole Foods, P.F. Chang's, and Williams-Sonoma, are going through a trough thanks to the decline in the "ability and willingness" of high-income consumers to pay top dollar for a venti coconut latte; organic, farm-raised salmon; $8 lettuce wraps; and an Emile Henry pie plate in a different color for every holiday meal.

Instead, he says, these consumers are trading down to Burger King (and, one would imagine, Dunkin Donuts for coffee; Trader Joe's for slabs of frozen salmon; and Dollar General for 2/$1 pie plates). Of course, I can make charts, too, and when I add DG (Dollar General) and BKC (Burger King) to the mix, I discover that their boats are falling with the same tide that's bringing down the luxe choices. It's harder to sell things to the poor, too!

Gross' theory is this: "the cost of living well is rising more rapidly than the overall cost of living." My theory is more like, "people are getting cheaper, and that goes for all of y'all."