Markets went almost nowhere last week as every piece of negative news was matched by a piece of positive news. From China to Europe to Brazil, a lot of interest rates went up, but US retail sales were surprisingly strong. Oil prices jumped to over $110 per barrel, but initial unemployment claims fell to a near recovery low. Portugal formally requested financial help, while merger and acquisition activity continued to power ahead with the announcement of the Texas Instruments (TXN) and National Semiconductor (NSM) merger. Both the Japanese and the Libyan situations aren't much better than they were a week ago, but those stories weren't plastered all over the front page either. That honour belonged to the Congressional budget deadlock.
Bankers Worldwide Try to Slow the Party with a Series of Rate Increases
Frankly, I continue to be surprised about how well the market is receiving negative news. I would have thought that such a broad range of countries raising interest rates, with the aim of slowing growth and inflation, would have been disastrous for worldwide stock markets. China increased its rates for the fourth time in six months to 6.31% in an attempt to hold down inflation rates that are nearing 5%. The European Central Bank made its first post-recession move, raising interest rates to 1.25% from 0.25%. Brazil also moved to slow growth by raising the tax on borrowed money to 3% from 1.5%, a de facto rate increase. Though interest rates take a while to take hold, they could begin to slow economic growth by the end of the year. The good news is that the higher rates should also slow inflation, which remains one of my biggest worries. It might also bring the current commodities boom to an end.
S&P Earnings Growth Could Approach 15% for First Quarter, Revenue 10%-Plus
I think the market is probably optimistic about the upcoming earnings season, which kicks off Monday with Alcoa's (AA) results. General expectations are for the earnings growth of the S&P 500 to approach 15% in the first quarter. Positive news out of companies (for example, Oracle (ORCL) and Accenture (ACN)) that report off-cycle earnings (not the typical March, June, September, December months) have people excited about the prospects for the first quarter. Earnings warnings seem to have been a bit sparse so far, too. Rumours are circulating that S&P 500 revenue growth might move into double digits in the first quarter--the first time that's happened since 2006. It's not all about cost-cutting this time around.
Positive First-Quarter Earnings Aren't in the Bag, Though
While prospects look good and management teams are sounding optimistic, there a few nagging fear factors. Certainly investors are anxious to see whether corporate margins will hold up in light of rampant commodities inflation. Also, some Japan effects could creep into the first quarter, although there is a better chance that will happen in the second quarter. Companies ranging from GAP (GPS) to Texas Instruments to AIG (AIG) have all mentioned that Japan issues could affect first-quarter results.
Retail Sales Reports for March Surprisingly Strong
Retailers reported a 2% gain in retail sales from March of last year to March of this year. Pundits (including me) had widely expected this metric would be negative, with the best case being flat results. An early Easter, near-perfect weather, and a quirk in the retail calendar produced truly stunning year-over-year results for March of 2010 (up 9%). Given poor weather this year, a late Easter, and high oil prices, all of us were expecting the worst. Nevertheless, like the Duracell Bunny, the consumer is just not giving up. Given my theory that the consumer ultimately drives all economic activity, this was by far the best economic news of last week. Recall that these results come in the face of a steady decline in "reported" consumer confidence.
Not All the Retail News Was Great
Looking at the data by category, luxury goods stores posted another large gain at 7%; at the other end of the economic spectrum, discount store sales were off 4.4% according to a report from the International Council of Shopping Centers. As indicated in our quarterly outlook piece, low-end consumers are feeling much more pressured by higher gasoline prices than those with higher incomes. Saks (SKS) and Nordstrom (JWN) reported gains of 11.1% and 5.1%. Meanwhile, Kohl's (KSS) and Target (TGT) showed declines of 6.5% and 5.5%, respectively.
Auto Sales Continue to Impress
Auto sales also indicate that the consumer isn't about to go back into hibernation just yet. Monthly auto sales continued to impress in March despite the jump in oil prices. However, higher gas prices did seem to move the mix toward more compact cars, as reported below by our auto analyst David Whiston. And for a change, the US manufacturers have some decent products to meet that need. The downside of David's report is that we are still a month or two away from seeing any dramatic impact from the Japanese situation.
Automakers reported good March new light-vehicle sales two weeks ago. Sales increased 16.9% from last March and the seasonally adjusted annual sales rate (SAAR) was 13.1 million, the second best sales rate since Cash for Clunkers in August 2009. The March 2010 SAAR was 11.7 million, and the February 2011 SAAR was 13.4 million. Every major automaker posted year-over-year gains except Toyota (TM), which declined 5.7% from last March. The good news is that so far $3.60 a gallon gas prices have not impacted sales, though the rise is causing a mix shift to cars over light trucks as happened in 2008. A telling statistic came from Ford's (F) monthly sales call, during which US sales boss George Pipas said the industry's compact and subcompact (B & C segment) share increased to 25% in March from 19% in December. However, the bad news in our opinion is that the sales impact from the Japan earthquake will likely start hurting the industry in late April and especially May. Aggregate OEM inventories are not too thin currently, but certain models such as hybrids and Lexus are low. Automotive News said the Prius has only an 18-day supply, and we think that is going to get worse. General Motors (GM) and Ford said they have a 75- and 52-day supply, respectively. Ford did note its small car inventory is getting low, which is not surprising given the success of the Fiesta and that production of the new Focus is just starting. A 60-day supply is generally considered healthy.
Gasoline Prices Could Explain Some of the Slowing in the Services Sector
In addition to the report on manufacturing, the Institute for Supply Management also provides data on the services sector. The ISM purchasing managers' report on services showed a decline to 57.3 from 59.7, a bigger decline than was reported in the manufacturing sector two weeks ago. While still in growth mode (any reading above 50 means growth), I was modestly disappointed in the March results. For many months, I have been hoping for more improvement in the services sector because it employs roughly 4 times as many people as the goods-producing parts of the economy.
Initial Unemployment Claims Continue Falling
Following the very positive monthly employment report two weeks ago, initial unemployment claims continued to fall, raising hopes that the strong March report will not be just a fluke. Last week, the weekly claims stood at 382,000 versus a pre-recession low of around 300,000 and a peak of about 700,000. It would appear that the generally sluggish US job recovery is a result of a lack of new jobs and not a continuing flood of new job losses.
While new jobs may be scarce, the daily fear of becoming the next person to be called in to the boss's office and dismissed has been lifted. That could explain why consumers have been willing to spend, even in the face of relatively high unemployment.
There are some other bright spots in the report too. The second best claims number of the 16-month recovery came despite the fact that the seasonal adjustment factor took the actual number of claims and increased it by about 7% (versus nearly halving the actual number early in the year when a lot of layoffs typically occur). I had feared these changing seasonal factors might cause a spike in the reported claims this spring. Thankfully, I have been wrong so far. The other news that I view as positive is that the number of people claiming unemployment under all programmes has fallen rather dramatically over the last year, to 8.5 million from 11.1 million people. Some of those 2.5 million people have found jobs, and some probably exhausted their benefits.
More Economic Data on the Way, Including Key Inflation Metrics
Expect more bad news on the inflation front this week as the US government reports both the consumer price index and the producer price index. I suppose the good news is that the rate of CPI inflation is expected to slow modestly from 0.5% (6% annualised) to a still huge 0.4% increase. The producer price index is expected to back off from its breathtaking increase of 1.6% (per month, not per year) to 0.7%. Food and energy remain the key culprits. Unfortunately, it appears those two factors are reaccelerating in April, as gasoline has just recently moved over the $4 level in some US cities.
Manufacturing Should Look a Little Better
On the manufacturing side, industrial production is expected to accelerate sharply in March to 0.6%, considerably better than last month's flat results (though February results were depressed by poor utility results). I am glad to see a strong manufacturing sector, but consumer spending remains the most important driver of the economy. Strong manufacturing sector employment data from the Bureau of Labor Statistics over the past several months suggest that the 0.6% consensus estimate for industrial production is in the right ballpark and may even prove a bit light. The Empire State purchasing managers' report will also give some hints about the manufacturing economy in April. The Empire State index has been more restrained than some of the other regional reports, so it will be interesting to see whether this index shows some improvement over the March reading of 17.
Shift in Chinese New Year Could Push Trade Deficit Down
The trade report for February is due on Tuesday, and the expectation is for the deficit to drop to $43 billion from $46 billion. Higher oil prices and consumer spending on imports will tend to increase the deficit report. Meanwhile special factors (including rushing imports to avoid the Chinese New Year) tended to inflate the January report, so the natural tendency would be for a relatively healthy drop in the trade deficit for February. I suspect the pluses and minuses will just about cancel each other out, producing a higher-than-expected deficit. Since this report is for February, slowing imports from Japan will not show up until next month's report at the earliest.
Retail Sales: The Devil Is in the Details
The comprehensive retail sales report for March should also show surprising strength based on strong results from individual stores last week and sharply higher oil prices. I should note, however, that sales are likely to be down from last month's unsustainably high growth rate of 1%, perhaps in the area of 0.5%. I will be more interested in analysing individual categories than the top-line number. I will be especially interested in restaurant spending because it may be one of the early indicators of consumers beginning to feel the squeeze of higher energy prices. Given what appears to be increased interest by consumers in spiffing up their current home, it will be interesting to see whether the volatile building materials sector will be able to post a decent gain. Also remember, that non-inflation-adjusted gasoline sales also tend to artificially inflate the results. Unlike most government reports, this one is not adjusted for inflation.
