I know I must sound like a broken record but the economic data week to week paints the same picture. Manufacturing related data released last week was generally quite positive, the housing market is still scraping along the bottom and jobless claims remain stubbornly elevated. I think that sentence has sufficed to describe the situation for months now but if this recovery is to be anything more than a temporary inventory rebuilding effort, that will have to change soon. The surprisingly robust consumption of the last few months would seem to have its limits if employment doesn’t start to turn around. Government transfer payments (extended unemployment benefits, tax credits, etc.) have been a significant factor in maintaining disposable income but that can’t continue indefinitely.
The weekly data got off to a good start with the Empire State Manufacturing survey from the NY Fed which showed continued strength in manufacturing. While the overall index did fall slightly from last month, the individual components were strong. New orders, shipments, inventories, delivery time and employment all rose strongly. The Philly Fed Survey released later in the week also continued to show expansion but was not quite as positive as the NY report with a draw in inventories. Both of the reports are correlated with Industrial Production which was released on Monday and was a bit disappointing. IP was up only 0.1% and that was due to an increase in utility production – which probably means it was due to cold weather. The manufacturing component fell although that was mostly due to changes in auto production. Ex autos manufacturing rose 0.1%. And year over year IP is up 1.7%. While the IP report was a bit weak, overall it appears that manufacturing is continuing to trend upward.
Same store retail sales reported by Redbook and ICSC Goldman both showed a 3.2% year over year rise. I have been consistently surprised by consumption in this recession as the public’s attitude seems at odds with their actions. Consumer confidence surveys are consistently negative, we hear numerous anectdotes about more frugal consumers and yet every time I venture out to a mall, the places are packed. The same is true of restaurants, at least here in Miami. One explanation may be the large number of “homeowners” who have stopped making their mortgage payments and therefore have more to spend on other things. Or at least that’s part of it; I don’t think there are enough of those people to really make that much difference but time will tell.
Speaking of real estate, housing starts were down for the month by 5.9% and a 575,000 annual rate. Permits were at a 612,000 rate. Weather had some effect but housing starts have just flattened out at a lower level. That will continue until we get more of the inventory worked off. Household formation has taken a hit in this recession – as it does in every recession – and Congress may still do something stupid on immigration but the fact is that with population growth we can’t build at this low rate for very long. Home builders are already starting to acquire land again and thanks to the Congressional bailout last year, they have cash on hand to do so. Didn’t know about the homebuilder bailout? Well, don’t feel left out; most people missed it. What Congress did was allow companies to write off losses against profits from up to five years ago and collect tax refunds. Lennar used this little manuever to collect a refund of $320 million, Beazer $101 million and KB Homes $100 million. Nice payday if you own a Congressman. Anyway, starts are limping along now at a low rate but I expect them to turn higher later this year.
We got three reports on prices last week. PPI and CPI showed little inflation but the import and export prices report wasn’t as kind. While month to month changes in all three reports were fairly benign the year over year numbers are far from it. Import prices rose 11.2% while export prices were up only 3.1%. A lot of these swings in import and export prices are due to the wide swings in commodity prices (primarily oil and agricultural products) but the big rise also reflects the price of a lower value for the dollar. I’ve said this before but it bears repeating – we can’t eliminate the trade deficit by devaluing the dollar because the price of the things we import will rise and most of those things aren’t optional. We will be importing oil for the forseeable future regardless of price. Most economists and the Fed expect low inflation due to “slack” in the economy- in other words they still cling to the Phillips curve view of the world that should have been discredited in the 70s - but I will let the value of the dollar guide me. If the dollar falls, that is inflation; the general rise in consumer prices or asset prices is the result. Right now we are still seeing price rises that are a result of last year’s devaluation.
Jobless claims fell slightly last week but this report continues to disappoint. We’re still stuck over 450,000 when we need numbers at least in the 300s to get any significant job growth. I don’t expect this to be a jobless recovery as most do. The recoveries from the last two recessions were marked by slow employment recoveries but the recessions were also marked by relatively mild drops in employment to begin with. The very rapid deterioration of jobs in this recession and the depth of the cuts argues for a more robust recovery. Rising productivity can only go so far and if the recovery continues companies will have to hire. But so far….it isn’t happening and my thesis may be just wrong. This is – by far – the most worrying economic statistic I follow.
Leading economic indicators continued to point to expansion but the details weren’t that impressive. Yield spread is still the largest positive contributor while consumer expectations, jobless claims and building permits are the big laggards. As I’ve said in the past consumer confidence isn’t something that concerns me but jobless claims are a big worry. The LEI spiked higher as the recovery started and has now stalled at the higher level. For a renewed uptrend we’ll need to see more positive components.
The large cap indices joined their smaller brethren in breaking out last week. The mid cap and small cap indices broke out first and it seemed only a matter of time before the large cap S&P 500 and Dow followed suit. That happened last week and despite a small sell off on Friday, it was a positive week. Breadth continues to be very strong but volume is still weak. There is broad participation in the rally with new highs swamping new lows. In other words, this is a healthy and pretty normal rally. The question – as always – is whether it can continue and for now I remain in the bullish camp. That doesn’t mean we can’t or won’t have corrections along the way, but until I see evidence that the economic recovery is stalling, I see no reason to alter my bullish stance on stocks.
The market is not especially expensive at these levels if earnings estimates are to be believed. And for the last few quarters analysts have been too pessimistic in their outlook and have had to play catch up in their estimates. Most estimate changes have been higher over that time but now the changes are more even handed with as many estimate cuts as rises. While some might take that as evidence that the analysts have caught up to reality I see it differently. I think once again that analysts are underestimating the earning power of US corporations. Productivity is rising rapidly and sales comparisons to last year are still fairly easy. Rising sales and rising productivity mean rapidly rising earnings. I expect the vast majority of companies to beat estimates again in the first quarter.
After the first quarter, well that’s a tougher call and depends on how the recovery proceeds. As the second quarter progresses we’ll have a better idea if the recovery is accelerating and can adjust our expectations concerning earnings. If employment starts to ramp up confidence in the recovery will climb and so will expectations. If employment doesn’t start to improve soon, I don’t see how positive economic momentum can be maintained. And we simply can’t get much higher stock prices without higher earnings because interest rates are already at rock bottom so multiple expansion seems unlikely. In fact, interest rates may be the more important factor in coming months as the Fed tries to work its way out of the quantitative easing business. If they screw it up and interest rates spike higher, all bets are off in the stock market. I don’t want to pre-judge the outcome but I have to say I am skeptical that Bernanke and Co. can pull this off without a major disruption somewhere.
Foreign markets continue to lag the US as they have since October. I still believe that foreign economies, particularly the emerging markets, offer better growth prospects over the long term than the US but it isn’t exactly a contrarian move to be bullish on those markets right now. In fact the two most contrarian plays right now are to be long US and Japanese stocks. The Japanese market in particular is a wallflower and cheap as hell. Stocks trade for about 1.4 times book value and includes some of the world’s best known brands. Yes, they look expensive on an earnings basis but that is based on earnings in a deep recession. From a macro viewpoint there are problems, most notably a large debt to GDP ratio, but I think they may finally be ready to address some long standing issues. Deflation has dogged the economy for years but the BOJ may finally be ready to push the yen lower and there seems little appetite for more Keynesian stimulus that has accomplished little over the last two decades. I have been out of the Japanese market for a while but the sun may be rising again.
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