U.S. stocks got hit Friday on valid currency concerns due to reckless government spending policies and unsound monetary actions from global central banks – in this particular case within Europe but they’re not the only violators of sound policy.   What has provided a tailwind for the market and global economy over the past few quarters is turning into a headwind; you can’t solve debt-related problems with more debt and you cannot return the market to a place that properly assesses risk by implementing another round of ultra-easy monetary policy. 

Early last week, stocks looked to be clawing back from the prior week’s sovereign-debt led weakness, but the last two trading sessions showed that rebound may prove misleading and a euro system break up is not off the table – not right away but one could see a “temporary” removal of the more troubled countries, a removal that stronger eurozone members will never intend to reinstate.  Are we watching the colossal collapse of the ultimate welfare state?  In time I believe that will be the case as European society doesn’t have the resolve to endure the intense economic pain necessary in the intermediate term to hold the zone together.  In the end any euro system that survives will be much smaller and operate around a model of incremental increases in self-reliance – the only model that can last.

The euro hit the 1.24 handle in early trading on Friday, which is what drove stock futures lower.  That weakness flowed into the official session as the European currency continued to fall to the 1.23 handle. 

The worst-performing sectors for the session were led by financials with basic material and industrial shares close behind.  All 10 major industry groups closed down, utilities and consumer staple shares were the relative winners, holding declines to under 1%. 

For the week, the broad market managed a 2.23% gain.  Although that was due to Monday’s big bounce off of the prior week’s 6.39% slide.  Combine the last two weeks and the S&P 500 is off by 4.2%. 

Market Activity for May 14, 2010

Retail Sales

Retail sales for April rose 0.4% (in line with expectations) after the spending surge of March that has now been revised up to 2.1% from the previously announced 1.6% increase.  That is wacko strong.  Jumps in retail activity like the results from March are unusual even when the labor market is healthy and incomes are strong – neither is the case today. 

So, total retail sales rose 0.4% last month.  But a look within the internals of the report showed things were much weaker than the headline number suggested – undoubtedly a payback from the March results. 

If the internals were weak, then what drove the headline number higher?  Let’s start with the normal exclusions – typical times economist remove to smooth the data.  Exclude autos and retail sales were up the same 0.4% (so you can’t say it was all autos); excluding gasoline, and retail sales were up the same 0.4%, (so you can’t say it was all gas stations). 

Let’s look at the other components.  It wasn’t furniture (this component was down 1.2% after powerful back-to-back readings of 2.1% and 2.4% in March and February – those tax credits being spent on the new house); it wasn’t electronics (down 0.4% after March’s -1.3%); it wasn’t food & beverage (down 0.5% after March’s -0.3%); it wasn’t clothing (down 1.0% after the 2.6% increase in March); it wasn’t sporting goods (down 1.9% after March’s 2.3% pick up); it wasn’t general merchandise (down 0.4% after March’s 0.6% increase); and it wasn’t department stores (down 1.5% after the 1.3% rise in March).  Dang, those are a lot of declines for April. 

What drove the number higher was a combination of auto, gasoline and building materials – all components that are removed from core retail sales, which is the reading that funnels directly into GDP.  That core retail sales figure fell 0.2% in April, the first meaningful decline in nine months.  The beginning of the unjustified spending rebound may have begun. 

Last week we talked about the killer crossover (when spending crosses and surpasses income ex transfer payments it’s only a matter of time until spending must take a hit).  Spending has been fueled by government cash -- which must soon disappear as we see in the deficit numbers, those home-borrower tax credits, and the money that has been freed up by strategic default.  This is not sustainable. 

Industrial Production (IP)

Industrial production increased 0.8% in April, fueled by another strong 1.0% climb in manufacturing output – manufacturing accounts for 80% of the IP index so it drove the entire IP increase for the month.  Manufacturing activity is up 6.0% from the weak period of a year-ago.

Utility and mining production, the other two components offset each other.  Mining production increased 1.4%, while utility production fell 1.3%. 

Mining activity, and to a degree factory work, had been boosted by a massive Chinese stimulus program that led to gargantuan build-out (reportedly much of which is occurring in abandoned provinces and thus will sit fallow).  Also helping is investor inundation into hard assets as faith in monetary authorities and fiat money is quickly eroding.  Mining activity has surged 8.6% from the depressed year-ago period.  (Most metals have since turned down over the past two weeks, although gold continues to rally.  If they don’t bounce back the mining sector will show activity decline a few months out.)

The utility component is more organic, vacancy rates and the breadth of economic activity drive this component – areas that are not so influenced by short-term stimulus measures.  Utility activity is down 2.6% from even the depressed activity of a year ago, showing things remain fragile. 

In terms of capacity being utilized, total capacity utilization (CU) rose to 73.7% in April from 73.1% in March – the long-term average is 80.6%.  Manufacturing CU hit 70.8%, the long-term average is 79.2%; mining CU hit 89.0%, the long-term average is 86.5%; utility CU fell to 77.4%, the long-term average is 86.6%. 

Business Inventories

Just as the wholesale inventory data hinted to earlier last week, the business inventories report was a good one.  Stockpiles increased 0.4% in March, with sales up a strong 2.3%.  The strong sales increase over the past six months will fuel production for a couple of quarters still.   However, if final demand fails to stage a durable comeback, sales will slump again and that means production will too.  It will be very interesting to watch what happens as government stimulus winds down and housing deals with the effective removal of the tax-credit crutch.

The Visible Hand

On Thursday night, the Senate passed fee restrictions on debit card transactions, which hit the shares of Visa and MasterCard -- down 9.88% and 8.55%, respectively.  It really looked like, in a market where it has become very difficult to find value, that these two stocks were a place to be as they benefit from increasing card transactions without being hampered by the credit troubles that are saddling bank credit-card businesses.  But then here comes the government.  As I’ve talked about for probably close to a year now, when Washington becomes this involved never underestimate their ability to royally screw things up.  When policy-by populism is in charge, it makes an already difficult market environment all the more challenging. 

Futures

U.S. stock-index futures are holding up nicely this morning even though the Shanghai Composite got wacked again last night.  Shanghai got smoked by 5%, and now down 26% from its most recent high, as the Chinese government continues to rein in that stimulus.  They have no choice right now or their housing bubble will only become a greater concern.

Have a great day!

Brent Vondera, Senior Analyst

Phone: 636-449-4900

www.acrinv.com