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Last week’s economic data continued the recent pattern of the recovery. Manufacturing remains strong, inflation is rising, housing is weak and employment remains a major issue. The economy is continuing to slowly recover but there is no sign of an acceleration that is sorely needed to reduce the unemployment rate. I suspect the next few months will be filled with considerable angst over the end of government stimulus. Only time will tell whether this economy can stand on its own but considering the glacial pace with stimulus, fears of further slowing - or another recession - seem likely to rise.
If the economy does slow it doesn’t appear it will be a result of subdued consumer spending. All the reports related to retail sales last week showed growth. The Goldman and Redbook reports both showed an acceleration from March with fairly robust year over year gains of 3-4%. Part of that is a calendar effect with Easter sales shifting into April but even considering that, same store sales gains are healthy. The official retail sales report also showed gains although part of the rise has to be attributed to higher prices. Retail sales rose 0.4% overall. Sales excluding autos and gasoline gained even more at 0.6%. Of course, gas isn’t the only thing rising in price so it is hard to say how much of that rise is attributable to inflation but my guess is that it is a considerable portion.
The report on import and export prices provides some insight. Import prices rose 2.7% in March and 9.7% year over year. With retail sales up 7.1% year over year and a considerable portion of our consumer goods being imported, the rise in the volume of goods sold isn’t nearly as robust as the dollar denominated gain. Export prices were also higher, rising 1.5% for the month and 9.5% year over year. That makes it somewhat disconcerting that exports fell in February. Higher prices may be crimping our ability to export larger volumes of goods. And it is obviously the volume that matters for everyone looking for a job. It also, by the way, lays waste to the notion that a nation can cure its trade deficit by devaluing the currency. The trade deficit fell by an almost imperceptible $1.2 billion in February and I would note that oil prices have risen since then so any improvement seems likely to prove ephemeral. Another worrisome note from the trade report was the drop in capital goods imports which would not seem to bode well for business investment.
Inventories grew by 0.5% in February, less than expected. The inventory to sales ratio is a fairly low 1.23. This might also show a reluctance by business to invest due to fears of a future slowdown. If the slowdown doesn’t arrive, inventory growth will have to be more robust in coming months which would be a positive for GDP growth.
Mortgage applications for purchase and refinance fell 4.7% and 7.7% respectively. Applications were higher in March but April is getting off to a very slow start. I’ve said it many times but it bears repeating; the cure for the housing inventory is to let prices fall. We will eventually find equilibrium but it doesn’t appear we are there yet.
Back on the inflation front, both PPI and CPI showed robust gains at the headline level and more subdued readings at the core. Producer prices rose 0.7% in March and 5.7% year over year. While there have been reports that producers are attempting to pass those price hikes through to consumers, the CPI report seems to show they aren’t having much success. CPI rose 0.5% in March and 2.7% year over year. That means either corporate profit margins are coming in or another round of layoffs might be in the offing. Neither sounds particularly appealing.
The good news on the manufacturing sector continued with the Empire State manufacturing survey reporting positive readings on all fronts except prices. New orders and shipments both rose and even the employment component showed gains. Industrial production also printed higher than expected at up 0.8%. Part of the gain was from an increase in utilities but most sectors were better. Auto production was higher leading durables to a 1% gain. Non durables rose 0.5% led by gains in chemicals and paper. Year over year industrial production is up 5.9%, an acceleration from February. The bottom line is that manufacturing continues to lead the recovery.
As usual I’ve saved the worst for last and as usual it involves employment. Jobless claims rose back above the 400k level last week, to 412k. It is too early to say the trend has changed on jobless claims but a jump of this magnitude is just dispiriting. Jobless claims have a high correlation with the stock market so investors should watch these numbers very carefully. If claims don’t resume the downtrend, Houston we have a problem.
Stocks were down on the week with US markets off fractionally and foreign markets getting the worst of it. Emerging markets were generally down as the monetary tightening cycle continues. India and China both reported pretty horrific inflation numbers and China announced another hike in reserve requirements for banks today. The rest of the world may be about to join the US in slower growth.
In the US, the negative tone was set early in the week by Alcoa which reported earnings less than expected. Earnings season is starting in earnest and so far the results have not met the extremely high expectations. Bank of America had another lousy quarter as their mortgage woes continue. Google put up pretty strong growth but it was less than expected and the new CEO inspired something less than confidence on the conference call. The stock fell hard on the news. The NASDAQ is looking decidedly toppy as even Apple is in correction mode.
The best performing sectors over the last few weeks are ones that are considered defensive. Pharmaceuticals, biotechs, consumer staples and utilities are now leading the market and the old growth leaders appear to be rolling over. If the end of QE II ends the commodity rally - and I think it might - the materials and energy sectors that have also led the market could come under pressure. Overall, it is hard to be bullish here especially with sentiment already so frothy.
I am expecting a transition period for markets ahead as the end of QE II is anticipated and then realized. As I said above there is likely to be a period of worry about future economic growth and I don’t see stocks continuing their rally until and unless investors believe growth can continue in the absence of stimulus. The end of QE II will also have an effect on commodities as their rise is tied to the falling dollar. If QE II pushed the dollar down, its end should at least stabilize the situation. Needless to say, I am not very enamored of risk assets right now. Bonds on the other hand are looking more attractive. If the end of QE II moderates inflation expectations and engenders a growth scare, bonds could prove a worthy hiding place.
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