Blue chips surge to record
By R. Mark Rogers, Senior Economist, Econoday
July 13, 2007
Last week saw a curious swing in the equity markets. Sentiment was a key driver at mid-week and boosted stocks sharply and to new records for the blue chips. Essentially, stocks soared to new highs despite near record highs for crude oil prices and mixed news on the consumer sector. Essentially, market expectations had been quite low and it did not take very much positive news to light the fireworks under equities — though only a week late for that metaphor. Both the Dow and the S&P 500 set new record highs on both Thursday and Friday.
Crude spot oil prices remained in the stratosphere last week, even spiking further by week end. Crude prices initially headed down with a dip on Monday as traders saw BP’s decision to close its Whitfield, Indiana refinery for unscheduled maintenance as a sign of lower-than-expected demand for oil. Crude rebounded on Tuesday, however, with announcements of various refineries having unexpected or continuing maintenance problems. These announcements boosted refined product prices and crude prices followed. Crude prices dipped on Wednesday on a government report showing an unexpected drop in crude stocks. Prices were little changed on Thursday. The week ended with crude prices being boosted by almost a buck and a half per barrel primarily due to closure of the North Sea's Central Area Transmission System gas pipeline, reducing production at the Erskine and Jade fields, and also to a lesser degree by a report from the International Energy Agency report saying that global energy consumption would increase next year. Overall, crude prices remain supported by strong global demand, continued jitters over supply from Nigeria, and by OPEC recalcitrance to increase output. While gasoline prices have held relatively steady in recent weeks, it is difficult to see higher crude prices not eventually passing through to higher gasoline prices.
The spot price per barrel for West Texas Intermediate was up last the week by $1.12 per barrel to close at $73.93 per barrel.
Equities, at an apparently very low base of expectations, benefited sharply by slightly positive company and economic news at mid-week. As a result the blue chips set new record closes. The week got off to an unassuming start with modest gains overall on Monday. The Dow got a boost from Boeing as its stock advanced with the rollout of its 787 Dreamliner the day before. Buyouts and stock repurchase announcements provided general support as did posturing before quarterly earnings announcements began. Investors generally were deciding that profits would be coming in healthier than previously expected since the second quarter showed stronger economic growth. Tuesday’s sentiment turned negative, pulling out support for stocks. The tone was set early in the day as a number of profit warnings came out, including by Sears Holdings, home builder D.R. Horton, Home Depot, and Standard & Poor’s. The financial sector slipped on Standard & Poor’s announcement that it will likely cut $12 billion in subprime-related debt. Tuesday afternoon, Fed Chairman Bernanke’s speech on “Inflation Expectations and Inflation Forecasting” – which was largely academic – was seen by the markets as not offering any clue that the Fed would be backing off from its anti-inflation bias soon. This led to a sharp sell off of equities in general with small caps being hardest hit.
Stocks partially rebounded on Wednesday despite the lack of notable corporate or economic news. The biggest event was Philadelphia Fed President Charles Plosser giving a presentation on “House Prices and Monetary Policy” in which he heavily downplayed the impact of housing weakness overall and strong housing price declines alleged by others. His comments were seen as comforting by the markets. Thursday saw equities in a huge rally, ending with the Dow leaping past the 13,800 mark with a 284 point gain for the day – its largest one day gain since October 15, 2002 when the index posted a gain of over 378 points. Getting things started was an announcement that Rio Tinto would be playing the role of white knight, agreeing to buy Alcan at a substantially higher margin than Alcoa’s hostile bid. While there was other merger news, the next big item behind the surge in equities was Wal-Mart’s reporting of same-store sales at 2.4 percent – notably higher than expectations. Clearly, it did not take much to get markets excited. However, American Eagle Outfitters came in strong with its June sales, adding to the market frenzy. Markets seemed to overlook weakness in some retailers such as Macy’s and J.C. Penney and what proved to be overall flat sales for most chain stores. What many have overlooked is that Thursday’s surge in equity prices was fueled also to a notable degree by short covering. There was heavy shorting of equities heading into the session and these bears had to buy into the rally to cover their short positions. Stocks climbed higher Friday on continued positive sentiment, on news of a jump in consumer sentiment, and by GE’s announcement of a stock buyback. The Dow ended the week closing over 13,900 while the S&P 500 also closed at a new high.
Last week, all major indexes were up. Major indexes were up as follows: the Dow, up 2.2 percent; the S&P 500, up 1.4 percent; the Nasdaq, up 1.5 percent; and the Russell 2000, up 0.4 percent.
Year-to-date, the Dow is up 11.6 percent; the S&P 500, up 9.5 percent; the Nasdaq, up 12.1 percent; and the Russell 2000 is up 8.6 percent.
Volatility was back in the bond markets last week. Net for the week the Treasury yield curve was mostly down – but not as much as early in the week. Rates eased moderately on Monday as investors decided that the prior Friday’s strong employment report had boosted rates perhaps a bit too much and buyers jumped in to take advantage of attractive rates. On Tuesday, note and bond rates dropped by double-digit basis points due to market reaction to Fed Chairman Ben Bernanke’s largely academic speech on inflation. Bernanke meticulously avoided any comments on current monetary policy and rates dropped notably as his comments were winding down and it became clear to traders that the Fed chairman was not giving the markets any hint of an imminent change in the FOMC’s anti-inflation bias. However, rates headed back up on Wednesday and Thursday. Rates were boosted moderately on Wednesday by further concern over subprime problems and by bond funds moving into equities as many saw Tuesday's drop in equities as excessive. Rates again rose moderately on Thursday with the prime mover being funds flowing into equities as investors jumped on the equity bandwagon. Retail sales were reported on Friday for June and came in much lower than expected which helped to ease rates at week end.
The Treasury yield curve was down last week except for the near end. Yields were down as follows: 2-year T-note, down 7 basis points; 3-year, down 7 basis points; 5-year, down 8 basis points; the 10-year bond, down 8 basis points; and the 30-year bond, down 8 basis points. The 3-month T-bill was up a slight 2 basis points.
Interest rates over the last six weeks have shown the most volatility since September and October of last year.
Weekly percent change column reflects percent changes for all components except interest rates. Interest rate changes are reflected in simple differences.
Last week’s economic data indicated that there may be a shift underway in the key drivers of growth. Growth may be slowing in the consumer sector but picking up in equipment investment and in exports.
The Fed may be getting part of its wished for slowing in economic growth with the consumer retrenching in June. Retail sales unexpectedly fell sharply in June. Overall retail sales fell 0.9 percent in June, following a 1.5 percent surge in May. It was the largest drop in retail sales since the August 2005 drop of 1.5 percent. For the latest month, weakness was widespread but led by declines in motor vehicle sales, furniture, and building materials. Excluding service station sales, retail sales decreased 0.9 percent in June, after a 1.3 percent boost in May. Excluding both motor vehicles and gas stations, sales declined 0.4 percent, following a 1.6 percent advance the month before. The market had forecast a 0.2 percent rise in sales excluding motor vehicles and gas station sales. The decline even exceeded the lower bound forecast for a 0.2 percent dip.
The June numbers are consistent with other retail sales numbers. Chain store reports were flat for the most recent week. Additionally – even though markets last week were whipped to a frenzy over Wal-Mart’s announcement of same-store sales at a 2.4 percent pace, the rate is still anemic. With the dip in June retail sales, second quarter GDP is even more likely to be well below a 3 percent annualized pace – which would please the Fed immensely. But the international trade sector may be working in the other direction as exports are looking healthy.
Year-on-year, overall retail sales in June fell to up 3.8 percent from up 5.1 percent in the month before. Excluding motor vehicles, May’s year-on-year sales declined to up 4.2 percent, compared to up 4.9 percent in May. Excluding motor vehicles and gas station sales, year-on-year sales in June fell to up 4.6 percent from up 5.0 percent the prior month.
The markets did not spend much time picking apart the May international trade numbers – largely because the overall number came in as expected. Still, there were trends within the details worth noting. It now appears that U.S. economic growth is edging away from the consumer sector and a little more toward exports. But, first, the overall numbers showed that the U.S. trade deficit widened in May to $60.0 billion from a revised $58.7 billion in April. Imports rose 2.3 percent while exports advanced 2.2 percent. Most of the worsening was in petroleum but the non-petroleum deficit widened also but only incrementally. The merchandise trade gap (Census basis) widened to $66.6 billion from a revised $64.8 billion deficit in April. The goods gap excluding petroleum grew to $42.7 billion in May from $42.4 billion the prior month.
Looking at import detail gives some interesting insight into business expectations in coming quarters. On the import side, overall merchandise imports increased $4.0 billion in May. Gains were led by industrial supplies, up $2.4 billion; capital goods, up $1.0 billion; and consumer goods, up $0.6 billion. Automotive fell $0.5 billion. Basically, businesses imported consumer types of goods at a very modest pace – apparently expecting a slowing in the consumer sector. Certainly, that is reasonable for the auto industry given the softening in motor vehicle sales lately. But non-auto consumer goods imports also were essentially flat. Businesses are slowing inventory building of consumer goods. What is being imported is oil and business equipment.
Export growth is remaining strong. On the export side, merchandise exports increased $2.3 billion in May. Gains were led by capital goods, up $1.9 billion, and industrial supplies, up $0.6 billion. Foods, feeds, & beverages and also automotive were down but barely. Exports for the year are being led by “other goods” and foods, feeds & beverages. “Other goods” consist of military goods, low value exports, and additions to export data from Canadian sources.
The bottom line is that the U.S. economy may be shifting away a little from being driven so much by the consumer sector and more by equipment investment and exports.
Even though import price inflation has come down slightly over the last four months, import prices have contributed significantly to the jump in overall CPI inflation and have not contributed to the improvement in core CPI inflation. Oil continues to drive up overall import prices, which rose a sizable 1.0 percent in June, following a 1.1 percent boost in May. Overall import prices have risen more than 1 percent in each of the last four months. The year-on-year rate seems tame at 2.3 percent in June but is sharply higher than minus 1.0 percent seen this past October. Excluding petroleum, import prices edged only 0.2 percent higher in the month though the year-on-year increase is on the steep side at 2.6 percent. This category, non-oil import prices, is closely watched by policy makers.
The year-on-year percent change for overall import prices stood at 2.3 percent in June, up from 1.4 percent in May. The continued decline in the value of the dollar in recent weeks will continue to exert upward pressure on import prices – likely a concern for the Fed.
The economy remains healthy but it may be in transition from being led heavily by the consumer to less so by the consumer and more by investment and exports. Recent data show a rebound in growth in the second quarter from the nearly flat first quarter but growth may be a little softer than expected a few weeks ago which means the Fed may yet get what it has wished for – below potential GDP growth. Still, high oil prices, moderately strong import prices, and a weak dollar are remaining inflation concerns.
Next week comes in with the most heavy hitter indicators for the month outside of the employment report. On the inflation front, we get new readings for PPI and CPI inflation. For manufacturing, the week starts out with the Empire State manufacturing index. Then the Federal Reserve’s industrial production figures for June come out Tuesday and the week ends with the Philly Fed index on Thursday. Mid-week, housing starts are posted for June giving us the latest pulse on the health of residential construction.
Fed Chairman Ben Bernanke likely will get a sneak peak at Wednesday’s CPI and housing starts numbers before he begins his semiannual testimony before Congress on Wednesday and Thursday.
FOMC minutes for the June 27-28 meeting come out Thursday afternoon.
The Empire State manufacturing index rose sharply in June to 25.8 from 8.0 in May and 3.8 in April. New orders and shipments indexes jumped notably for the month. Other manufacturing surveys have come in strong, confirming a similar pattern for manufacturing in June – including the Chicago NAPM, the Philly Fed, and ISM. Markets will be watching to see if this strength continues as suggested by the surveys’ orders data.
Empire State Manufacturing Survey Consensus Forecast for July 07: 17.5
Range: 4.5 to 22.0
The producer price index continued to surge on higher energy costs as the overall PPI jumped 0.9 percent in May, following a 0.7 percent boost in April. The core rate was better behaved but still firmed in May to a 0.2 percent increase, following no change in both March and April. With crude oil prices continuing to rise in June, we should see continued upward pressure on the overall PPI.
PPI Consensus Forecast for June 07: +0.1 percent
Range: -0.2 to +0.4 percent
PPI ex food & energy Consensus Forecast for June 07: +0.2 percent
Range: +0.1 to +0.2 percent
Industrial production was unchanged in May, following a 0.4 percent boost the prior month. The manufacturing component rose only 0.1 percent in June with weakness in consumer goods while business equipment was flat. Capacity utilization slipped 2 tenths in June to 81.3 percent. More recently, aggregate production hours, as seen in the employment situation report, strengthened to a 0.3 percent boost in June from a 0.1 percent rise in May – suggesting that manufacturing will improve for the month.
Industrial production Consensus Forecast for June: +0.4 percent
Range: 0.0 to +0.6 percent
Capacity utilization Consensus Forecast for June 07: 81.5 percent
Range: 81.3 to 81.8 percent
The consumer price index was mixed in May as the overall consumer price index in May jumped 0.7 percent, following a 0.4 percent rise in April while the core CPI inflation rate eased with a 0.1 percent increase in May, following a 0.2 percent rise in April. Energy prices again boosted the overall CPI as energy prices increased 5.4 percent. It is going to be hard to see the core CPI repeat May’s 0.1 percent rise given that it took declines in apparel, new & used motor vehicles, and transportation to soften it up.
CPI Consensus Forecast for June 07: +0.1 percent
Range: -0.2 to +0.2 percent
CPI ex food & energy Consensus Forecast for June 07: +0.2 percent
Range: +0.1 to +0.2 percent
Housing starts in May slipped 2.1 percent, following a revised 1.0 percent increase in April. Numerous housing indicators point toward continued weakness in starts. Months’ supply both for existing and new homes for sale remain high. The pending home sales index fell 3.5 percent in May, following a 3.4 percent drop in April, leaving a year-on-year decline of 13.3 percent for May. For now, homebuilders have little incentive to boost starts.
Housing starts Consensus Forecast for June 07: 1.45 million-unit rate
Range: 1.42 million to 1.49 million-unit rate
Initial jobless claims fell 12,000 to 308,000 in the July 7 week, pushing down the four-week average by 1,500 to 317,750. Initial claims have been declining in recent weeks, pointing to even tighter conditions in the labor market.
Jobless Claims Consensus Forecast for 7/14/07: 310,000
Range: 298,000 to 315,000
The Conference Board's index of leading indicators rose 0.3 percent in May, up from a 0.3 percent decline in April. May's gains, which in theory point to a pick up in future growth, were led by jobless claims, stocks, and building permits.
Leading indicators Consensus Forecast for June 07: -0.1 percent
Range: -0.3 to +0.2 percent
The general business conditions component of the Philadelphia Fed's business outlook survey index surged to 18.0 in June from 4.2 May. This is a sharp contrast to near flat readings from March through May. New orders also picked up sharply. Prices paid were on the high side at 29.7 in June but competition has kept the prices received index modest as indicated by a reading of 5.1 in June.
Philadelphia Fed survey Consensus Forecast for July 07: 14.0
Range: 7.0 to 22.0
|
