As I suspected, the positive earnings news out of individual companies dwarfed the mostly positive macroeconomic data released last week. The outstanding news from individual companies was very broad-based, ranging from consumer goods leader Apple to luxury goods retailer Coach to manufacturing giant Illinois Tool Works. Many corporations produced the trifecta of improved sales, stunning margins, and higher forecasts for the year ahead.
The macroeconomic data for the week wasn't so bad, either. Both new and existing home sales showed gains from month to month and exceeded expectations as well. Initial unemployment claims were finally down again after a couple of weeks of moving the wrong way. Excluding aircraft, durable goods orders were also surprisingly good. I love to see strength in durable goods orders, because today's orders are tomorrow's production and shipment numbers. Strong orders, increasing production, and slim inventories all bode well for higher employment during the coming months. Higher employment will mean even more dollars in consumer pockets. Let the virtuous cycle continue.
I continue to believe that the economic momentum will be hard to stop. Fears that modestly higher interest rates or an expiring housing credit are going to derail this recovery are misplaced. Just as occurred with the expiration of the cash for clunkers programme, there could be a couple of soft months after the home buyers' credit expires or rates rise. Ultimately sales should stabilise at levels higher than before. The underlying strength in corporate earnings and consumer spending is just too difficult to deny.
Key Trends
Although every industry is in a slightly different stage of recovery, there a few common themes out of this quarter's earnings results:
1. Sales Growth at Last
2. Huge Operating Leverage/Margin Improvement
3. Strong Non-US Markets, Especially Asia/Brazil
4. Building Momentum Each Month
First, most companies are returning to a meaningful level of sales growth. During several recent quarters, we had to settle for sales declining at slower and slower rates.
While 5%-10% growth seemed to be the norm for a lot of industrial concerns, Apple posted stunning sales growth of 50%. A lot of the improvement in corporate revenues went straight to the bottom line, too. In the case of Apple, revenues were up 50% but earnings were up a more stunning 90%.
In the industrial world, margins at manufacturing giant ITW bounced back to the 13% range from the low single digits a year ago and a typical peak margin of 17% or so.
A lot of the best growth was outside the US, with even Apple making note of strong sales in Asia. Likewise, manufacturer Eaton saw its best sales results in Asia and Brazil, while management noted that US growth was finally showing renewed vigour.
Several companies also noted that sales momentum increased during each month of the quarter, which should bode well for sales results in the months ahead. For example, Morningstar housing analyst Eric Landry noted that ITW reported sales growth of just 4% in January. ITW sales jumped 6% in February, and a very impressive 13% in March.
Although far less widespread, there were a few other things I saw this quarter worth mentioning:
Hiring Resumes, Especially at Software Firms
Inventory Shortages Constraining Sales
We heard several software companies, including Oracle and Google, mention they were ramping up hiring. A recent Wall Street Journal article even noted a bidding war for some mid-level developers. As earnings continue to pick up, I believe the hiring spigots will open in more industries during the second quarter.
It is also interesting that we have already begun to hear more about parts shortages. Our tech and telecom team notes that Seagate, a manufacturer of computer disk drives, complained that they could have easily shipped more drives if inventories had been higher. That said, it bears mentioning that Morningstar's tech team is currently not recommending these stocks.
As the tech team has reported before, flash memory (used in cameras, jump drives, and as replacement for hard drives) is also approaching a shortage situation. I think that market analysts who proclaim that there is a ton of excess capacity in our economy need to take a little closer look at individual categories.
Real Estate Shows Some Signs of Life--for Now
Both new and existing home sales were strong in the month of March, exceeding general expectations. Existing homes were up 6.8% from February and almost 16% from a year ago at 5.3 million units.
Our housing analyst, Eric Landry, points out that the homebuyers credit is helping, but it isn't helping nearly as much as when sales jumped to well over 6 million units in October and November 2009. Because the bounce hasn't been as big from this round of credits, Landry anticipates that the post-credit decline should also be a bit milder, and 4.5-5.5 million units might prove to be the new normal for existing home sales.
I have always believed that employment growth (which I expect to improve), incomes, overall confidence, and population growth will all offset the expiration of the housing credit after a couple of months of lag time.
New home sales for March jumped by an even more stunning 27% to 411,000 versus expectations of just 320,000 units. In fact, Landry notes that the last time sequential growth exceeded that white-hot pace was in 1963, when new home sales grew 31%. Since new home sales must be signed by April to get the credit, and new home sales are recognised when contracts are signed, we should see one more good month before they dip again. Since existing home sales are recognised in the official statistic at closing (which typically happens two or three months after contract signing), existing home sales should peak in June, two months later than new home sales. I am glad to see the good numbers, which are likely to have a positive effect on GDP. However, it's important to maintain perspective. There's not much sense in getting excited now, only to get depressed again in July.
Real GDP Growth Likely to Surprise on the Upside This Week
I believe next week's GDP growth rate will come in at 4% or higher. Although the consensus estimates for the quarter have trended upward to 3.5% from 3% over the last few weeks of positive economic news, I believe those estimates could prove to be wide of the mark.
I think that stocks should react well to the news while I think that bonds will take another hit with another surprisingly strong quarter of growth. Within the GDP forecast, I believe the consumer expenditures for the quarter could be in the 3.5%-4.0% range, which would make it by far the best quarter since the recovery began last June. It would represent a sharp improvement from the more meagre 1.6% growth rate reported for the December quarter.
This quarter I would also suspect that the inventory adjustment will be a smaller, but still significant, contributor to GDP (an additional 1%-2% versus close to 4% in December). Exports and business spending will also kick in a little help this quarter, while construction, especially nonresidential, could hurt overall results along with stronger imports.
This week will also bring consumer income data as well as expenditures for the month of March. Incomes may still be a bit stagnant while expenditures should be up 0.6% or more. I base my optimism on retail sales that were up 1.6% in March with minimal inflation. The income category should gain strength in the months ahead as the economy adds 100,000-200,000 jobs.
