Summer rally afterall? Econoday Simply Economics 7/14/00 By Evelina M. Tainer, Chief Economist

Technology stocks back in favor
Stock prices continued on their upbeat note again this week. To the relief of many, higher than expected earnings were released by some large companies. The markets labeled Alan Greenspan's speeches "benign". He said nothing about monetary or economic policy on Tuesday and Wednesday but rather confined his remarks to mostly encouraging comments about technology and advances in efficiency. On tap next week is the first of his two congressional testimonies on monetary policy. Mr. Greenspan offered a distraction from the market's focus on corporate results. But earnings news will continue to dominate the market's attention in the upcoming weeks.

Merger activity and good earnings have stimulated otherwise meandering markets into what has been tentatively labeled a summer rally. The announced merger between UBS of Switzerland and Paine Webber invigorated the Dow Industrials. The Dow and especially the Nasdaq were stirred by the better than expected profits, which made memories of some earnings warnings fade away. The Nasdaq rose on better than expected profits from Yahoo!, and images of higher profits and rising markets for the tech sector emerged. The markets noted the producer price and retail trade data and then shifted their to focus on Mr. Greenspan's upcoming testimony instead.

The Dow and Nasdaq have been outperformed so far this year by the Toronto Stock Exchange Composite 300, the Paris CAC, and the Frankfurt DAX. Of the five major indexes graphed below, the Japan Nikkei 225 is the worst performing, down about 9.5 percent so far this year. The TSE is outperforming everyone. It’s up over 28 percent after rocketing up 30 percent last year.

Bond market's worry beads
Early in the week, the bond market drifted along with no special news. Investors contended with a heavy outpouring of corporate and agency bonds and were distracted by absorption problems away from the treasury market. Market players could not glean any market moving words from Alan Greenspan's speeches on Tuesday and Wednesday. Thursday's economic reports on import/export prices and unemployment claims were both market friendly and bond prices rose. Weekly unemployment data were fraught with seasonal closing problems and holiday distortions. Investors once again became nervous about Japan's economy, buying U.S. Treasuries after a major non-financial company was allowed to file for bankruptcy.

The producer price index data showed a benign price picture except for energy. However, the retail sales report was not as sanguine. It wasn't June sales that upset the bond market so much, but rather the hefty upward revisions to April and May, which only proved that the consumer is still shopping. This raised the specter of an interest rate increase at the August 22 FOMC meeting. However, many traders are looking beyond Friday's data and to Alan Greenspan's congressional testimony on July 20 (Senate) and July 25 (House).

The dollar also rises
Currency flows related to international merger activity pushed the dollar higher and the euro lower. The foreign exchange markets ignored the substantial upward revision in European Monetary Union first-quarter gross domestic product to a 3.7 percent annual rate. Mergers and acquisitions activity appears to be moving in the wrong direction for the euro. Further announcements of EMU companies buying U.S. firms could push the common currency lower. Foreign investors bought a record $141 billion of U.S. securities in the first quarter, the Securities Industry Association said in June, bolstering the dollar and helping to weaken the euro.

The dollar rose and the yen fell when a major Japanese firm declared bankruptcy, placing greater pressures on the flailing Japanese banking sector as other companies in critical financial conditions consider their options. This is compounded by continued Bank of Japan rhetoric concerning their zero rate interest policy (ZIRP). The Bank would like to see an end to it but has been pressured especially by the Ministry of Finance, which would like to see it continued until Japanese growth is more stable. The markets are questioning the Bank of Japan's resolve given the bankruptcy news and the potential strains it may cause.

 

Markets at a Glance
Treasury Securities	12/31/99	July 7	July 14	Weekly Change
30-year Bond	6.48%	5.86%	5.88	+ 2 BP
10-year Note	6.43%	6.00%	6.10	+10 BP
5-year Note	6.34%	6.09%	6.25	+16 BP
2-year Note	6.24%	6.27%	6.40	+13 BP
Stock Prices
DJIA	11497*	10637*	10807*	+1.61 %
S&P 500	1469*	1479*	1510*	+2.10%
NASDAQ Composite	4069*	4023*	4243*	+5.46 %
Russell 2000	505*	528*	532*	+0.76 %
Exchange Rates
Euro/$	1.0008	00.9476	0.9375	-1.07 %
Yen/$	102.40	107.83	107.87	0.04 %
Commodity Prices
Crude Oil ($/barrel)	$25.60	$30.38	$31.30	+3.03 %
Gold ($/ounce)	$289.60	$284.70	$282.00	- 1.00 %
(BP = basis points; stock price indices are rounded)

The consumer hasn't stopped spending yet
Retail sales climbed 0.5 percent in June after an upwardly revised increase of 0.3 percent in May. Second quarter consumer spending looks stronger than originally thought — apparently consumers are not done spending yet, although they are not spending with quite the same abandon as they were a few months ago! A surprise 1.5 percent jump in auto sales was a major factor behind the increase. Excluding autos, sales rose a more sedate 0.2 percent in June after a revised 0.5 percent increase in May.

Durable goods rebounded in June, climbing 0.7 percent after remaining flat in May. The increase largely came from rising auto sales. However, building material and hardware sales continued to fall as would be expected with the current downward trend in housing starts. Furniture and appliance store sales also dipped in June after a revised increase in May. Higher interest rates typically hamper durable goods spending, though this obviously didn't apply to autos in June.

Nondurable retail sales rose 0.4 percent in June after an upwardly revised increase of 0.5 percent in May. Sales at gasoline service stations were the main contributor to the increase, climbing 1.3 percent. However sales in apparel stores dropped 1.9 percent and drug and proprietary stores were down 0.8 percent.

The bottom-line on the consumer? The retail sales chart above clearly depicts a decided moderation in the pace of consumer spending despite the June pickup in auto sales. The three-month moving average of retail sales shows that the underlying trend is simply lower than it was several months ago. The Fed’s past six interest rate hikes are undoubtedly reducing housing demand, leading to weakness in durable goods such as furniture and appliances.

Higher energy prices have to be affecting consumer spending also. When consumers spend a few cents more per gallon on their weekly fill-up, the extra money going to gasoline expenditures may not even be noticeable. It could be the cost of a coke or a candy bar. But gasoline prices have surged in the past couple of months. The money going to gas is tangible to consumers — who now have less discretionary income for other purchases.

Higher energy prices are bound to choke off some consumer spending. In addition to higher rates, energy prices may be cooling down the economy this summer. It is debatable whether the Fed has completed its tightening rounds, and the pickup in retail sales is certainly going to be worrisome for policy makers.

Energy is the culprit
As expected, the producer price index rose 0.6 percent in June after it was unchanged in May. June's increase was caused by a 5.1 percent surge in energy prices. Gasoline prices soared 11.8 percent while heating oil prices rose 8.4 percent. Natural gas costs increased by a record 5.7 percent, surpassing the previous record increase in January 1997. Food prices continued to decline, helping to put a damper on the index. As a result, the PPI was up 3.8 percent in June relative to a year ago, about the same as May.

Excluding the volatile food and energy sector, the core PPI declined 0.1 percent. Analysts had expected an increase of 0.1 percent. Car prices declined 0.5 percent after rising 0.9 percent in May. Tobacco prices dropped 1.8 percent and paper products declined 1.3 percent. The PPI excluding food and energy is up 1.4 percent when compared with last year.

Market players have focused their attention on the PPI at earlier stages of production for hints at the direction of future price movements. The intermediate materials index turned up 0.9 after falling 0.1 percent in May. Energy prices, which were up 4.7 percent, bear the brunt of the blame for the increase. Intermediate goods prices excluding food and energy rose 0.2 percent in June after a 0.1 percent increase in May. At the same time, crude materials prices jumped 5.8 percent led by a jump of 13.8 percent in crude oil prices and a 23.9 percent increase in the cost of natural gas. Yet crude goods prices excluding food and energy fell 1.3 percent in June after sliding 0.3 percent in May.

The Labor Department reported June import and export price data earlier this week. Import prices jumped 0.8 percent in June, following on the previous month's 0.6 percent increase. Once again, higher oil prices are behind the accelerated price hike. Yet, non-oil import prices were unchanged for the month and are only 1.1 percent higher than a year ago. Export prices slipped 0.1 percent, reversing the previous month’s increase. Export prices are up 1.9 percent from a year ago. On the whole, these figures are relatively favorable, as they are no longer accelerating.

The bottom-line on inflation? The inflation news was relatively favorable for June with the exception of energy prices where the bulk of the problems remain. Financial market players liked the data because it indicates that the Fed doesn’t have a lot further to go in terms of its tightening cycle. But make no mistake, the Fed is not done. Most economists are predicting at least one more 25 basis point rate hike. But these inflation figures won’t settle the debate.

Industrial production cools down
The index of industrial production rose a weaker than expected 0.2 percent in June after a larger increases of 0.5 percent and 0.8 percent, respectively, in May and April. Production of both consumer goods and construction supplies declined on the month. However, business equipment posted another healthy gain of 9.2 percent when compared with last year. If the growth is coming from capital spending, that could help to boost productivity in the future.

The capacity utilization rate slipped to 82.1 percent in June but is significantly higher than a year ago. The old rules of thumb suggest that inflationary pressures begin to develop after the operating rate hits 83 percent.

THE BOTTOM LINE
The bulk of this week's economic data was released as everyone was headed out for the weekend. The data were mixed suggesting that inflation, with the big exception of energy prices, is muted. However, retail sales surprised. These data are subject to large revisions in both size and direction of change and should be treated carefully. On a trend basis, consumer spending does seem to be growing more slowly, and that is exactly what the Federal Reserve would like to see. Its interest rate increases are finally working. It is too soon to tell what the picture will look like by the time the Fed meets on August 22. There will be a lot of economic data between now and then.

In between, investors will listen very closely to Fed Chairman Alan Greenspan's testimony on Thursday, looking for clues to monetary policy direction.

Looking Ahead: Week of July 17 to July 21
Market News International compiles this market consensus which surveys about 20 economists each week.

Monday
Business inventories should increase 0.4 percent in May, slightly faster than the pace set in April. Sales are expected to jump 0.8 percent, reversing April's 0.6 percent drop. This could lead to a decline in the inventory-to-sales ratio.

Tuesday
The consumer price index is expected to increase 0.5 percent. This incorporates a boost in energy prices. Excluding energy, the CPI should post a gain of 0.2 percent, in line with the past several months.

Wednesday
The consensus shows the May international trade balance on goods and services is expected to reveal a shortfall of $30.5 billion compared with a $30.4 billion trade deficit in April. Economists are predicting increases in both exports and imports.

Thursday
Market participants are expecting new jobless claims to drop to 315,000 in the week ended July 15 from last week's 319,000 level. Claims are likely to be rather volatile in the next several weeks since summer factory shutdown schedules are not exact from year to year.

Market players are looking for housing starts to decline about 1.6 percent to a 1.575 million-unit rate, less than the previous month’s decline.

The Philadelphia Fed’s business outlook survey is expected to rise to 5 in July from June’s level of 1.7. This would show pretty healthy production activity in this Fed district.