18 Feb 2011 Recovery Creeping Along
It was a mixed week for economic data, but a pretty good one for markets. The S&P looks to finish up close to 1% and the 7-10 year Treasury index is up .25% for the week so far. Manufacturing news and corporate earnings continue strong, but the consumer may be taking a break. And still bouncing along the bottom, jobs and housing showed few signs of recovery.
The consumer, who represents 70% of the economy, seems to be taking a break following a busy holiday season. Headline sales in January posted a moderate gain, largely attributable to higher gasoline prices. Retail sales gained 0.3%, following 0.5% and .08% gains in December and November, respectively. The gain was aided by a 0.8% advance for general merchandise, which include department stores, and a 0.5% rise in motor vehicles and parts. Overall retail sales on a year-ago basis in January advanced to 7.8% from 7.6% the previous month.
Price increases in food and energy are driving up inflation numbers. The government reported its latest read this week at the consumer and at the producer levels. The Consumer Price Index in January increased 0.4%, which follows a .04% jump in December. Excluding food and energy, CPI inflation in January posted at a 0.2% rise, compared December’s increase of 0.1% and exceeding expectations for a 0.1% gain. Hikes in energy commodities and food accounted for over two thirds of the all items increase according to Bloomberg.
The core rate was propelled by a 1.0% jump in apparel and 2.2% boost in airline fares. Medical care commodities gained 0.5%. On an annualized basis, CPI inflation increased to 1.7% (seasonally adjusted) from 1.4% in December. The core rate rose to 0.9% from 0.6%.
At the producer level prices rose at a strong 0.8% and followed a 0.9% increase in December. Even at the core rate, the Producer Price Index rose 0.5%, after a 0.2% increase in December. Energy continued its surge, up 1.8% following a 2.8% increase in December. Bloomberg points out that nearly forty percent of the January advance can be traced to the index for pharmaceutical preparations, which moved up 1.4%. For the year, overall PPI slipped to 3.7% from 4.1% in December (seasonally adjusted).
A separate report following import prices confirmed the strength in energy and food. Prices of goods brought into this country prices jumped 1.5% propelled by petroleum up 14.3% and food, feed, and beverages up 14.8% on an annualized basis.
Earlier in the week, an article in the Wall Street Journal pointed out that raw material costs are rising faster than corporate revenue. Author Jonathan Cheng says “blame it on soaring prices of everything from cotton to copper and corn.” He says “profits are being squeezed margins more markedly than many analysts anticipated, and is serving as a worrying sign for future earnings.”
About three-quarters of the companies in the S&P 500 stock index have reported their earnings so far. Some 25% of those companies have posted lower margins in the latest quarter, according to Morgan Stanley. S&P says operating margins for companies in the 500 index for the latest quarter have come in at 8.69%, down from margins of 8.95% for the S&P 500 in the third quarter of last year. Erin Browne, of Citigroup says “I think this quarter [is] a wake-up call. We’re seeing these stocks get hit on margins and sell off dramatically, . . . and it’s only going to continue as we move through 2011.”
On the positive side, however, revenue grew an average of 9.8% in the fourth quarter, significantly outpacing estimates of 3.8% growth. Demand is growing and companies’ profits are real, not just temporarily propped up by cost-cutting. Bank of America Merrill Lynch equity strategist Priya Hariani, says she is unfazed by the shrinking margins, adding that worries are being stoked by “a handful of companies making headlines.” She says current margins are sustainable with low interest rates, low corporate borrowings, low corporate-tax rates, and low wage costs. She goes on to say “there are some pockets of the S&P 500 that get pressured, including retailers and food-product companies, but net-net, S&P 500 commodity input costs are low. . . . you won’t see the same rapid pace of margin expansion, but it doesn’t mean we’ll see any meaningful margin contraction.”
Manufacturing in the US remains robust. The regional report from the NY Fed known as the Empire State index rose more than 3-1/2 points to 15.43 to indicate monthly growth in general activity at an accelerating rate. The Philly Fed also reported strength in its region. The report’s headline index, which is not a composite of components but simply a subjective assessment of general business conditions, surged to 35.9 in the February reading vs. January’s 19.3.
The Index of Leading Indicators rose a modest 0.1% in January. The biggest contributor is the yield spread reflecting low short term rates against rising long rates. A slowing in deliveries was the second biggest indication of future economic strength followed by the stock market and by consumer expectations, the latter having shown tangible improvement so far this year.
The housing market index was unchanged in February for a fourth straight and abysmal reading of 16. Bloomberg notes a pick-up in current sales, but traffic remains depressed at only 12. The National Association of Home Builders reports pockets of optimism though it says prospective buyers are concerned about selling their existing homes and, even those that are well qualified, are still facing difficulty finding credit. Home builders also say that competition from foreclosed properties is tough.
Housing construction was mixed in January and remained at a very soft level. Housing starts in January surged 14.6% after slipping 5.1% the month before. The January annualized pace of 0.596 million units is down 2.6% on a year-ago basis. The latest gain was led by a monthly 77.7% surge in multifamily starts, following a 10.8% increase the month before. The single-family component slipped 1.0% after declining 8.4% in December.
Housing permits, in contrast, fell 10.4% in January after improving 15.3% in December. Overall permits came in at an annualized rate of 0.562 million units and are down 10.7% on a year-ago basis. The latest decrease was led by the multifamily component which was down a monthly 23.8% while single-family permits declined 4.8%.
Jobless claims provided no signs of improvement in employment. Initial claims rose a steep 25,000 in the February 12th week to 410,000. The prior week was revised 2,000 higher to 385,000. The four-week average rose 1,750 in the latest week to 417,750 to show no significant change from mid-January in a comparison that doesn’t point to improvement for the February employment report.
The recovery continues to look sustainable, but weak. It is not strong enough to promote significant job growth, but it is improving. Washington will be busy in the coming weeks with budget cuts. Some of these cuts may put further pressure on jobs.
We are embarking on a path rarely experienced in our history; that of rebuilding our economy while shrinking the reach, power, and expense of federal government. For this recovery to succeed, business must grow and hire while government shrinks and fires. If the “change” demanded by voters in 2010 is to be sustained, business must not only soak up the 5% or 6% of the currently unemployed workers, but also those who will be laid off from government jobs in the coming years. Failure to do so risks voter sentiment swinging back toward bigger government. Mr. Obama is right when he says US businesses should grow through innovation. But he is wrong if he thinks government should not shrink in proportion, faster if possible.
Have a great weekend and remember that our office is closed in observance of Presidents’ Day on Monday.