Corporate management's comments on orders and shipments have generally been very bullish, in sharp contrast to macroeconomic data that suggest the manufacturing growth boom is coming to a rapid end.
With the exception of industrial production figures, most indicators this week were relatively minor releases. So this week's market moves were largely driven by a rate hike in China and relatively positive corporate earnings news, especially from the industrials and tech sectors.
The market is particularly sensitive to news out of China, because the country has been so important in pulling the world economy out of its slump. Markets feared that higher rates would mean slower growth for China, which would in turn import fewer commodities and capital goods from developed economies. Better-than-expected gross domestic product and production numbers out of China for the third quarter (announced later in the week) assuaged some of the fears surrounding the rate hike.
Real estate data for the week were more positive as new housing starts, while still exceptionally depressed, came in better than expected. The architectural billing index, a great leading indicator for commercial construction, flipped into growth territory for the first time since 2008.
News on the employment front also showed some signs of life this week as initial unemployment claims fell again and even the lowly airline industry began recalling airline pilots by the hundreds. This came on the heels of news from the retail industry that many planned greater (and sooner) retail hiring for the holidays than in 2009. There may be room for a little more optimism on the employment front in the months ahead.
Corporate Earnings Drive Markets Again
Corporate earnings reports this week were thankfully more positive than last week's rather mixed showing. Earnings from restaurants, airlines, technology, and industrial sectors were particularly strong. I was pleased to see the service sector components of the economy, heretofore a poor stepsister to the manufacturing sector, begin to show some signs of life. Recall that the service component of consumer spending is almost twice as large as the goods-related portion.
A far greater portion of services spending remains in the United States, too. This is in sharp contrast to consumer goods, many of which are imported and therefore aren't additive to the GDP.
Restaurants, usually an early cycle performer, have generally been a little more sluggish than usual during this recovery. However, the news was better (though not perfect) this week with stellar results out of Chipotle Mexican Grill (CMG), Cheesecake Factory (CAKE), and BJ's Restaurants (BJRI), in addition to continuing good results at McDonald's (MCD). So while the world obsesses over naturally slowing manufacturing data, I have my eyes on consumer spending, especially on services, and consumer incomes.
Will the Earnings Report Boost Last?
I should also caution that while quarterly earnings reports have been a catalyst for the stock market for much of the year, when those reports begin to die down in the second month of the quarter, markets have generally faltered a bit. When the excitement of earnings reports fades, investors are left staring at macroeconomic data, which often look less robust than the earnings data.
Industrial Production Data Disappoints
The industrial production figures were down mildly, as presaged by recent purchasing manager reports. Industrial production was down 0.2% for the month, its first decline of the year. It is fascinating--and a bit disconcerting--that corporate management's comments on orders and shipments were generally very bullish, in sharp contrast to macroeconomic data that suggest the manufacturing growth boom is coming to a rapid end.
The good news is that manufacturing is not typically the key driver at this point of a recovery, making some of the macro versus micro manufacturing data controversy moot. Also at this point in the recovery, I tend to give a little more weight to positive management statements than macro data. Investor credibility issues and even legal issues tend to keep managements from being artificially bullish on their own businesses. I doubt that management teams are making any of this up.
Macro Manufacturing Data Had Anomalies This Summer
On the other hand, some of the manufacturing macro data grew a little suspect this summer. According to Fed data, auto production went from 7.4 million units in June to 8.4 million units in July and back to 7.8 million units in August. In truth, actual production was pretty flat during that period. What happened is that this year GM had no summer shutdown to change over models, but the Fed still applied seasonal adjustment factors as it usually does. That inflated some months of data and deflated others. While most of this comes out in the wash if you look at the data over periods longer than a couple of months, analysts waiting on every data point may have been fooled into thinking we had strength followed by weakness, when instead we had reasonably constant data. While I can't prove it, it seems that industrial production and the purchasing manager data do the best when autos are doing well.
Auto production has had a decent run over the last year, and I don't expect much growth in auto production for the rest of the year. This is probably what will keep a lid on manufacturing data in the months ahead. Again, that is why I am watching consumer services so closely.
As for the company data, the head of our industrials team summed up the quarterly results thus far as follows:
We've received our first heavy dosage of industrial earnings over the past week and a half, as bellwethers from General Electric (GE), Caterpillar (CAT), and UPS (UPS), as well as proverbial underperformers such as the legacy airlines, have all reported. Impressively, many industrial and consumer-based businesses experienced strong results during the quarter, giving their respective management teams enough confidence to increase estimates, in some cases substantially, for the coming year. On the other end of the spectrum, a few companies reported unimpressive growth and declining operating margins as a result. Even so, order rates are generally impressive, even for the latest-cycle businesses in our universe.While overseas sales, especially in Latin America, were highlighted in many of the reports, most companies went out of their way to point out that the U.S. business wasn't so bad either.
GDP due Next Week, Growth Should Accelerate from 1.7% in the Second Quarter to over 2.0% for the Third Quarter
This week's video discusses our outlook for GDP growth for the third quarter, which will be reported next Friday. Sorry for giving a broad range here, but I expect GDP growth of 2.0%-3.0%, while the consensus is just under 2%. Driving growth should be consumer expenditure growth of 2.5% or more (based on data for two months of the quarter plus retail sales for the third month).
The swing factor in the quarter will be inventories, private investment, and net exports. I suspect net exports to have only a small (1% or less) impact on GDP versus over 3% negative in the June quarter. I also believe that business investment spending on equipment and software will make a meaningful contribution to GDP growth, though less than the huge contribution it provided in the June quarter. I don't think inventories will do much to the GDP estimate, one way or the other, but it is the biggest swing factor in the calculation.
More Meaningless Real Estate Data Due Next Week
Existing home sales should show a small single-digit increase again for September based on growth in the pending sales data announced earlier this month. Again, the data show what we already know: Housing isn't getting better in a hurry, but a least it has stabilized for now. However, slower sales due to foreclosure moratoriums and robo-signer issues are likely to be more pronounced in October and November. So-called distress sales, which include foreclosure, generally represent 25% or more of monthly sales.
Case-Shiller pricing data are likely to report a small but not disastrous decline. The Case-Shiller data is a three-month moving average through August, so this will be only the second month without the positive effect of the homebuyers' credit.
Durable Goods Orders--Signs of Renewed Life in Manufacturing-land?
Last month, durable goods orders fell 1.5%, largely on the back of disappointing transportation orders. This month, improved transportation equipments orders are likely to drive the headline number up over 2%. Even excluding transportation, durable goods orders are expected to be up 0.4% according to consensus, which seems just a bit high given the relative weakness of recent purchasing manager surveys.
