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Investing Specialists

Market Runs Hot and Cold with Economic Indicators

Things looked up this week on the data front, but there will still be bumps on the road ahead.

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This week's economic indicators provided welcome improvements over the prior two weeks' worth of data, which were modestly disappointing. While the numbers this week were uniformly positive, I caution investors not to over-react to one week's worth of highly jittery indicators, even if they do bolster my optimistic view of the economy. Next week could bring more numbers that might not look as good, including the government's pesky retail sales report.

As investors, we need to get over our manic-depressive relationships to economic indicators. In the two weeks prior to this latest week, markets lost almost 4% as the indicators turned in a decidedly mixed performance. This week, positive data points managed to turn the markets around with the S&P gaining 4.5%. My hope is that a flow of positive third-quarter earnings reports over the next month will take away some of the market's microscopic focus on the economic indicators, at least temporarily.

Good GDP Growth and Productivity Should Drive Positive Earnings Surprises
Given the better GDP numbers (I predict around 3.5% growth in the September quarter), I am expecting revenues could look a little better than last quarter. At the same time, employment (the key cost driver in most businesses), continued its downward trend in the third quarter. In aggregate, it seems likely that margins will get better as revenues increase and costs fall (see After the Productivity Spike, Expect More 3Q Pleasant Surprises).

I would expect companies with meaningful export exposure to do particularly well, as non-U.S. economies appear to be turning faster than the U.S. economy for now. In the quarters ahead, a weaker dollar should begin to aid results after several quarters (including the third quarter) of relatively negative effects. In short, I am hopeful about this earnings season and will be listening closely to corporate conference calls to glean further information about the direction of the economy.

Retailers Finally Turning, Consumer Showing Some Signs of Life
Perhaps the most surprising (and positive number) I got this week was the retail sales report from Thomson-Reuters that showed year-over-year retail same-store sales jumped 0.6% in September versus August's abysmal negative 0.9% number. Cooler weather, a later Labor Day and back-to-school season, as well as a greater willingness by consumers to spend all contributed to the results. Also, Lehman Brothers' failure in September 2008 accelerated the downward trend in consumer spending last year and made this month's comparison easier.

Even knowing all those details, almost every retailer reported September sales that were considerably better than expected. From  Nordstrom (JWN) and  Abercrombie & Finch (ANF) serving higher-end customers to  TJ Maxx (TJX),  Ross Stores (ROST), and  Aeropostale (ARO) serving more cost-conscious markets, results were better or less worse than expected. However, the cost-conscious segment continued its relative strength while high-end stores showed markedly less deterioration. I was most encouraged by the 5.5% improvement at  Kohl's (KSS), which I view as a more middle-of-the-road retailer that is more representative of most consumers than either of the two extremes.

As a warning, next week we get the official government retail sales number that will likely show a 2%-3% decline. That number will include not only chain stores but gasoline stations and auto dealers. The end of the Cash for Clunkers program means the auto segment of the report is likely to be down more than 15% from August. And gasoline prices also could negatively impact sales that are not adjusted for inflation. Hopefully, the market will be able to take a nuanced view of the report and go behind the headline number. But I am not holding my breath.

Initial Unemployment Claims Back on the Right Track
In other positive news, initial unemployment claims fell 33,000 to 521,000 this week, one of the larger declines in recent months. Claims have been showing some improvement in four of the last five weeks, and the four-week moving average, which smoothes out weekly volatility, was at its lowest level since January 2009.

Again this series is volatile from week to week, so I would focus more on the improvement in trend than on any one week's numbers. The trend is still a little slower than I would like, but at least it is moving in the right direction. In a typical recession, new claims fall to about half the amount gained during the recession in about four months. We are now six months past the peak in claims and have reduced claims just 37%. Only the recession of 1973-1975 has taken longer to recover the magical 50% of new claims.

DateInitial ClaimsFour Week Moving Average7/4/2009569,000607,0007/11/2009524,000585,0007/18/2009559,000567,2507/25/2009589,000560,2508/1/2009554,000556,5008/8/2009561,000565,7508/15/2009580,000571,0008/22/2009574,000567,2508/29/2009576,000572,7509/5/2009557,000571,7509/12/2009550,000564,2509/19/2009534,000554,2509/26/2009554,000548,75010/3/2009521,000539,750

ISM Non-Manufacturing Survey Turns Positive
The week kicked off with positive news from the ISM (Institute of Supply Management) that announced its Non-Manufacturing Survey of Business. This is the indicator for service businesses that is the counterpoint to the Manufacturing Index reported last week. The non-manufacturing indicator has a much shorter track record and is generally not as good at spotting changes in trends. However, services represent a much larger part of the economy than manufacturing, so it is worth some attention.

For September the Non-Manufacturing Survey moved up to 50.9 from 48.4, crossing the 50 line, which means more businesses are seeing expansion than contraction. (The manufacturing index moved over 50 one month earlier.) The qualitative comments in the report were quite positive and included:

  • "Sales are very steady and have risen some each month in the past six months. The bottom is now here." (Construction)
  • "Economic recovery turnaround has begun in the financial services sector; however, cautious expense management is still practiced." (Finance & Insurance)
  • "Continue to see signs of slow recovery, but customers are still putting orders off until the beginning of 2010." (Professional, Scientific & Technical Services)

Alcoa and Pepsi Results Support My Positive Thesis, But Dollar Effects Linger
Earnings season also officially began this week, and some of the initial reports were positive and reinforce my optimism.  Alcoa  (AA) reported a small profit versus the expectation of a loss. While better cost controls were the prime driver of the surprise, volumes were a little better in some businesses as well. Currency was less negative than some past quarters, but nevertheless a drag. Alcoa exemplifies what we expect from many companies this quarter, better margins due to tight cost controls, i.e. employment, with revenues better in some segments and some lingering currency effects.  PepsiCo (PEP) also topped expectations, mostly due to better results overseas (see Overseas Markets Add Spark to U.S. Economy).

I don't think Pepsi's overseas growth was a fluke, either. This week's favorable U.S. trade numbers showed increasing exports for the fourth month in a row and performed better than expectations. Given a stronger pick-up in overseas economies and a weaker dollar, I suspect better international sales could be an important driver of results for many S&P 500 companies over the next six months.

Heavy Data Flow Next Week Likely to Be Mixed; Earnings Season Could Take Off the Heat
Besides the potentially negative retail sales report, next week brings a couple of regional manufacturing surveys. These usually aren't that important, but given a little weakness in last month's national data (though it was still showing growth), investors will be hoping to see an improving trend in the regional indicators. Industrial production is due on Friday and should show good continuing gains after bottoming in June based on the positive ISM survey. The Consumer Price Index is due Wednesday and will probably continue to show just modest increases, perhaps about 0.2% (2.4% annualized).

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Robert Johnson, CFA does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.