Market Looks for Excuse to End the Party
The market may find reasons to stall in the short term, but a strong economy and powerful corporate earnings cycle will be key drivers in the long run.
The U.S. markets this week remained firmly in the clutches of international developments. Stocks rallied sharply when it appeared the Greek debt situation was reaching a resolution and sank again on Friday when China continued to tighten the reins on aggressive bank lending.
Contributing to market weakness on Friday was the announcement that eurozone growth in the fourth quarter was a meager 0.1%, less than the anticipated growth of 0.3%. Recall that the U.S. economy grew at 5.7% over that same time frame. Whether these overseas developments were a direct cause of the U.S. market volatility or just a coincidence is yet to be determined.
There are other reasons markets might be sloppy. Many U.S. equity markets were up over 70% from their March lows, Washington appears in disarray, some economists are openly worrying about life after stimulus, and a very jolly earnings season is winding down. It wouldn't take much of an additional excuse to shut down the stock market's party, at least temporarily.
However, a strong economy and a surprisingly powerful corporate earnings cycle will be the key drivers for the market longer term.
Despite Exports' Importance, I Stand By My 4% GDP Growth Forecast
The world is more interconnected than ever before. Exports currently make up almost 12% of GDP compared with 5% in the early 1970s. Gross exports contributed 1.8% of the 2.2% GDP growth in the third quarter and 1.9% of the 5.7% growth in the fourth quarter.
Exports played an important role in pulling the U.S. economy out of its slump and offset weaker-than-normal consumer spending during this recovery. Overall, my real GDP forecast for 2010 is for 4% real growth with about a 1% contribution from exports.
So the market's concerns about overseas economies this week aren't totally misplaced. However, the U.S. consumer will be a far bigger contributor to 2010 GDP growth. A 1% change in consumer spending means a 0.7% increase in GDP, while a 1% change in exports produces just a 0.1% change in GDP.
A better employment outlook (realistically, less fear of being fired), a dramatically improved stock market (and improved overall balance sheet), reinstatement of 401(k) matches, and the lifting of salary freezes will all be important drivers in the consumer recovery of 2010.
Retail Sales Surprisingly Strong
The news on the consumer front was excellent based on what consumers were actually buying, but less good when examining consumer expectations as measured by the University of Michigan Sentiment Survey.
Retail sales for January were up 0.5% on a sequential basis from December and up 4.7% over a year ago. Just as importantly, both November and December were revised meaningfully upward. The improvement was widespread with only furniture and building materials showing meaningful declines. Strong home sales in the fourth quarter, which is a leading indicator, should lead to some improvement in even these laggard categories in the near future.
The Census Bureau Retail Sales Report data this week was more consistent than usual with the previous week's same-store sales reports from individual companies. Last week's company reports showed considerably improved sales at luxury retailers (probably driven by strong stock market gains) and continued strength in value-conscious retailers like TJX (TJX) and Ross Stores (ROST). The report also puts a highly positive spin on the whole holiday selling season (all sales November through January) that are now officially reported at +4.3% compared with the same period a year ago. Not bad for a group considered to be the walking dead.
Mid-Month Consumer Confidence Weaker than January, Booming vs. a Year Ago
The mid-month University of Michigan sentiment indicator provided a slightly less bullish outlook. The index came in at 73.7 versus 74.4 the prior month and general expectations of 76.0.
However, the number is still well off its bottom of 56.3 in February 2009 and is still up about 30% from a year ago. To me, the large year-over-year jump is more relevant than the month-to-month blips. Interestingly, the current conditions part of the index set a new record for this recovery while the future expectations section was down meaningfully. Like a lot of analysts and economists, consumers aren't true believers in this economy just yet.
Just When You Thought the Data Integrity Couldn't Get Any Worse...
I have been writing for several months that expiring and then not-expiring tax credits, holiday closures, and large seasonal adjustment factors would be complicating economic data interpretation. Even my normally reliable initial unemployment claims data were messed up for many weeks because of the holidays and processing delays.
Now we have not one but two massive snow storms in the Mid-Atlantic states. That will affect retail sales numbers and a lot of the housing data in the region. Then we have the Toyota (TM) vehicle recalls that may be putting a crimp in auto sales while diehard Toyota buyers decide their next move. More importantly production was shut down, which affects overall GDP.
Initial Claims Data: Clean and Strong for One Week Anyway
By far the best news of the week was that initial unemployment claims dropped 43,000 to 440,000, very near the best levels of this recovery. This is one of the first weeks of data that weren't affected directly by a holiday or by large processing backlogs created by the holidays.
The good number gives me confidence that the jobs situation is still improving. However, weather will play games with these numbers in the weeks ahead. The snow surely idled a lot of people, particularly anybody in the construction industry. But those same people may not have been able to find an unemployment office that was open, either. So claims may dip and then soar the following week. It depends.
To make matters worse, this is the week that data is gathered for the monthly employment report. Therefore, my forecast for job growth may be pushed out yet another month.
On the Docket: Manufacturing, Inflation, and Housing
Housing starts have been trending down for some time as fears about the expiration of the housing credit pressured new-home starts. With the ground rules of the extended credit widely available since early November, I expect that starts in January will rebound from the 557,000 starts reported in December.
Most of the purchasing managers' reports have been on an absolute tear lately, so I suspect that industrial production will be up more than 1% in January following a 0.6% jump in December. I am convinced that a stronger manufacturing sector will eventually spill over into more spending on consumer services and lead to additional employment.
Inflation In Check for a Couple of Months
At the end of the week, I suspect the Consumer Price Index will come in at 0.1% -0.2% or 1%-2% annualized. I think the energy and the housing/rent-related components will keep the overall rate in check, while some categories will continue to show meaningful growth.
Despite relatively stagnant wages, consumers have been better off because of deflation/low inflation. As prices have moved back up over the last few months, some of that consumer purchasing power has been eroded. Therefore I will be keeping a close watch on CPI when it is reported on Friday.
The silver lining of the Chinese tightening lending programs might be less demand for commodities, which could lead to lower commodity prices, especially oil, in the short term. Longer term, I think inflation will accelerate to 3% later in the year, hopefully when the economy is on firmer ground.
Robert Johnson, CFA does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.