U.S. stock indices closed pretty much flat on Friday with the Dow managing a slight gain, while the S&P 500 and NASDAQ Composite ended fractionally lower. 

The market was conflicted by the day’s data.  Retail sales for February posted much better-than-expected numbers; however, the latest gauge of consumer confidence slipped for the second straight month and business inventories showed this segment is not going to provide anywhere near the boost to first-quarter GDP as it did during the final three months of 2009.

It was a good week though, with the broad market up 1% .  This follows the strong 3.1% bounce in the prior week. 

Sector performance was split with half moving lower, led by utilities and financials, and half gaining ground on the session, led by industrials and basic material shares.

Commodity prices got a lift from the news that President Obama will appoint San Francisco Fed Bank President Janet Yellen as vice chairman of the Federal Reserve, replacing the retiring Donald Kohn.  Janet Yellen is by far the biggest dove (meaning she believes in very loose policy and lacks inflation vigilance) within the Fed system.  

In fact, President Obama has two other vacancies to fill on the Federal Reserve board and the Yellen pick is a sign he’s going to choose those that believe monetary policy will need to remain extremely accommodative for a long time.  The dollar got crushed on the news.

“Let the good times roll!”  Stocks are going to like this move, at least in the short term.  However, the longer the Fed keeps policy floored, the more difficult it will be for the economy and the stock market to adjust to either the unwind of this policy or the damaging ramifications from this unprecedented level of accommodation   

Market Activity for March 12, 2010

Rhetoric Heats Up

In his annual news conference, Chinese Premier Wen Jiabao turned the table on U.S. policymakers, calling them out on doing the same thing that they accuse the Chinese of – implementing policies that keep the value of the home currency lower in an attempt to boost export activity. 

Wen’s statements were quite assertive, which shouldn’t be a surprise since they are the largest U.S. creditor (along with Japan).  If we don’t begin to manage this relationship properly, this may become another serious risk for the market. 

We’ve got to get serious about things; implementing policies that are frankly quixotic will only do us harm.  We must engage in the policies that will drive job growth as a larger tax base is the only way we’ll boost revenues and ease the debt burden – dollar strength will follow.  (Unfortunately, we can forget about spending cuts right now, in fact we’re moving in the opposite direction.)  

Instead of an overbearing government, it must get out of the way of the private sector.  Eliminating the corporate income tax is a good way to start.  This will incentivize U.S. subsidiaries that are currently headquartered abroad to come back home and international firms will be increasingly attracted as well.  A massive level of job creation will result.  What we lose in corporate tax collection, we’ll more than make up via higher individual income tax receipts. 

Retail Sales

The Commerce Department reported that retail sales for February came in much better-than-expected.  The overall reading rose 0.3% for the month vs.expectations for a 0.2% decline and the ex-autos reading jumped 0.8% vs. an expected increase of just 0.1%.  The core retail sales reading, which gets plugged into the personal consumption number of GDP, jumped 0.9% and has gotten off to an awesome start for the first quarter. 

I’ve got to say, these figures are confusing to me.  Yes, the retail figures are rising against depressed levels but these are month-over-month readings so the comparisons are not that weak.  Some may recall several weeks back I noted that we should expect consumer activity to jump in March and April as those homebuyer tax credits roll in.  (Those credits are “refundable,” meaning that even if the homebuyer didn’t have a tax liability equal to the amount of the $8,000 credit they would still be getting a refund check.)  Possibly, the solid readings of the past two months (particularly on the core sales reading) reflect spending in anticipation of those refund checks.

But back to the numbers, the 0.3% increase in total retail sales for the month followed a January reading that was revised significantly lower -- +0.1% vs. the previously believed +0.5%.  However, the 0.8% rise on the ex-auto reading followed a results that was barely revised down -- +0.5% instead of the +0.6% initially believed to be the case. 

On the core reading, which excludes autos, building materials and gas station receipts, sales surged 0.9% after a strong 0.6% in January.  Unless the March figure declines in a big way or this Feb. reading is revised substantially lower, personal consumption is going to boost GDP for the first quarter.  I believe this number is going to lead economists to increase their estimates for Q1 GDP, which are currently at the weak level (for this point in an expansion) of 2.9%. 

Outside of autos and health/personal care, most segments of the report looked really good.  Furniture was up 0.7% (there’s that anticipation of the homebuyers’ tax refund); electronics sales surged 3.7% (had to get a bigger screen for the Super Bowl party, that 40 incher just wasn’t gonna do); grocery stores jumped 1.3% (maybe some weather-related boost here); strangely, online sales were flat (one would think this segment to have been boosted by the snowstorms); eating & drinking (bars and restaurants) sales were up 0.9%.

I continue to believe there will be a payback in the coming months for this recently strong rise in retail sales; we shouldn’t forget that the jobless rate remains near 10%, under-employment near 17% (and deteriorated in February) and long-term unemployment is just a touch below the record level hit in the prior month.  Government transfer payments remain at record levels of 20% of total income, but this doesn’t explain all of this increase in spending.  Then again, I have noticed that household debt as a percentage of disposable income has begun to rise again, very close to the all-time high hit in March 2008. 

Business Inventories

The Commerce Department also released results on business inventories, showing companies held stockpiles unchanged in January from the previous month as sales advanced 0.6%.  Recall a couple of days back we reported on wholesale inventories for January, this number is that wholesales figure plus retail stockpiles. 

So business inventories have failed to advance for a second-straight month, which followed a two-month build that followed a 13-month slashing of stockpiles.  As the aforementioned retail sales results will help to boost the current quarter’s GDP print, this inventory data will not be of help – although this data is just one month into the quarter so big readings for Feb. and March could materialize. 

The report showed that business sales rose in January, marking the eighth month of advance – although, manufacturing sales cooled in January.  The inventory/sales ratio fell to 1.25 months’ worth of supply, just a tick above the all-time low of 1.24 months’ worth hit in January 2006. 

So things are in place for a significant rebuilding process to take hold, which means production levels that would result in big GDP reading for a couple of quarters.  The problem is businesses lack the confidence to restock.  Until confidence is restored, the inventory dynamic will be lacking. 

Have a great day!

Brent Vondera, Senior Analyst