The broad market bounced between gain and loss all day on Friday as traders weren’t sure what to make of the data and the Bernanke speech, but a little bounce in the final half hour delivered a positive close. The NASDAQ Composite was able to cement a solid gain thanks to a strong profit report from Google.  Financials and industrials weighed on the Dow Industrial Average, which closed down.

A couple of the day’s economic releases surprised to the upside and that may have thrown a little doubt about just how aggressive QE2 will be.  Bernanke’s speech Friday morning was pretty much as expected, he gave the green light to QE2 (of course the latest FOMC minutes already did that though) even as he was pretty vague – he’s not going to front run the Committee before they officially vote for the program.  But a better-than-expected manufacturing reading out of New York and a retail sales print that not only beat for the reporting month but also saw the previous reading revised higher may have sparked a little concern as to the degree of additional easing. 

Tech, consumer discretionary (on the heels of that retail sales report, but ignored the confidence reading – we’ll get to that below) and health-care led the broad market higher. Seven of the 10 major groups gained ground for the session.

Volume was rip-roaring, coming in 20% above the three-month average.  For three sessions now, volume has been at what’s considered more normal levels.  Here come the performance chasers. 

Market Activity for October 15, 2010

Retail Sales

The Commerce Department released a September retail sales report that was a stunner to the upside, beating estimates on the headline, ex-auto and ex-auto & gas readings.  Also, the August numbers were all revised up big time. 

Headline retail sales rose 0.6% in September (expected to come in at 0.4%) and excluding autos rose 0.4% (expected at 0.3%).  Excluding autos and gasoline purchases sales rose 0.4% (expected at 0.3%).  All of these readings were revised up for August – headline up 0.7% (previously reported at 0.4%); ex-autos up 1.0% (previously at 0.6%) and ex-auto & gas up 0.9% (previously reported at 0.5%).

For September, all components except clothing posted pretty big gains.  The segments posting the largest increases were: Auto & vehicle parts, up a large 1.6% last month; electronics jumped 1.5%; and internet sales up 1.0%. Even furniture sales, with a beaten down housing market, was up 0.5% for its third-straight monthly increase.

I’ve got to say I’m confounded by these numbers. Average hourly earnings have weakened again over the past four months, the job market remains weak and consumer confidence remains at recessionary levels.  Of course, we do have government transfer payments as a percentage of total income hitting a new high of 20%; interest rates floored; an enormous number living in their homes rent-free for 15 months on average (and reports of some even renting the house out  as they remain in default) and the stock market that is clearly helping to boost spending.  But still, the figures are surprising.  There’s either a huge pay back to these results in the months ahead, or I’m really missing something.

Empire Manufacturing

And Empire smoked the estimate too, as the NY Fed’s gauge of factory activity came in at a solid reading of 15.73 for October when it was supposed to remain weak (expectations were for a reading of 6).  This followed three months of considerable deterioration and I expected the reading to post a negative number.

And the internals of the report looked good overall.  New orders bounced to 12.90 from 4.33 in September; unfilled orders and delivery times remained negative but improved by 4 and 5 points, respectively; number of employees hit a high level of 21.67 after 14.93, although even the strong readings in the previous two months didn’t result in actual factory hiring as the past two employment reports showed manufacturing-sector declines. 

The weakest reading of the report came from inventories, as that index slid to -11.67 from 1.49 and is at the deepest level of contraction since January.

Nevertheless, this is a solid report and it’s the first regional we receive for the month so it gets October factory activity kicked off on a very good note.  Remember, my call is that manufacturing would continue to slide and be in contraction mode by year end.  If the other regionals show the same level of vitality then I’m going to have to reassess that outlook – but I’ll certainly wait for those other releases.

University of Michigan Consumer Sentiment

The latest from the UofM’s consumer sentiment survey showed consumers remained very negative on economic conditions in October, which makes those retail sales figures all the more surprising.  Then again, if the rebound in stock prices is the main driver of retail activity right now then the confidence surveys are not going to be reliable.  I doubt the more affluent consumers (the segment most driven by the wealth effect) are among the respondents to these surveys.

The overall reading slipped to 67.9 in October from 68.2 in September as it was pushed lower by consumers’ view of current conditions.

The current conditions index slid 6.6 points to 73.0 from 79.6 in September.  This is at the low point of the 1981-82 recession and well below the low hit in the 1990-91, but holding above the low of 1980 and obviously the all-time bottom hit in late 2008 . 

The expectations index (hopes of things a year from now) increased four points to 64.6 in September.  So it too remains at recessionary levels but is holding above lows hit in past contractions. 

Business Inventories

Finally, as it was a big day for data, the Commerce Department reported that business inventories rose a better-than-expected 0.6% in August (expected to come in at 0.5%) after the upwardly revised 1.1% (previously 1.0%) in June.  Yes, this data has a good lag to it but August and July data are still important for that Q3 GDP we’ll get at the end of the month.

So, the inventory cycle continued in the third quarter, but as the rise in stockpiles has outpaced that of business sales for the fourth month in a row now, that cycle is coming to an end if sales fail to bounce back.  (Business sales rose just 0.1% in August and are down slightly since April.)  At which point, GDP will have to rely on other segments. 

And quickly on business sales, we really need to see final demand come through because the profits by massive payroll slashing has played its margin-boosting role – squeezed all the juice out of that lemon.  Further, if commodity prices continue to go higher, yet firms continue to have about zilch in terms of pricing power, it puts the kibosh on margins, and there goes the profit cycle.  We shall see.

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Have a great day!

Brent Vondera, Senior Analyst

Phone: 636-449-4900