U.S. stocks shook off another day of economic reports, that on balance, printed numbers on the wrong side of expectations.  CPI, retail sales, consumer confidence and business inventories all missed, although industrial production did surpass its estimate.  But missed expectations lose meaning after the Fed Chairman overtly brags about sending stock prices higher as he did on Thursday – more on that below.  Such fodder is all the Wall Street trader needs to fuel their appetite for quick profits without regard for the damage that follows. 

Financials, energy and tech led the broad market higher.  Consumer staples, telecoms and health care were the day’s laggards.

The S&P 500 has gained for seven weeks in a row now, a very rare duration of uninterrupted rally; all major domestic indices closed higher for the sixth week in seven.

The Dollar Index retreated again on Friday, down every day last week to the lowest end of the latest trading range.  And the CRB, as most commodities are priced in U.S. dollars, inched higher to a new post-crisis high.  About half of the components pulled back for the session, but the price increases in cocoa, the energy complex, copper and corn were enough to send the index higher.

The earnings season has gotten off to a good start, as S&P 500 profits are up 21.3% on a share-weighted basis.  Although less than 10% of companies have reported thus far; results will get rolling in earnest this week.

The revival in profits has been big, but we’re coming off of the weakest levels ever (S&P 500 EPS fell 87% during the crisis, which was worse than the 72% during the early stages of the Great Depression) so comps have been fantastically easy to beat.  However, things will get more difficult beginning this quarter (not this earnings season, which is for Q4 but for this quarter, or the following earnings season).  To wit, now that we’re five quarters into this profit cycle extremely easy year-ago comps are gone.  In the meantime, firms will have to manage around higher input costs while their pricing power remains challenged due to continued de-leveraging (even though consumers seemed to take a respite from debt reduction of late) and a very high jobless rate. 

Market Activity for January 14, 2011

There were several economic releases on Friday and I try to touch just briefly on each to keep this letter as short as possible without abandoning substance.  But I must first discuss the increasing disturbing comments from the Federal Reserve chairman.

Even those who have been critical of the manner in which monetary policy has been directed had to be stunned to hear Mr. Bernanke, at the FDIC-sponsored forum on small-business lending, actually brag on Thursday that the S&P 500 is up 20%, and the Russell 2000 up 30% since his August 27 speech in which he signaled QE2 was coming.  The fact that a central bank Chairman, at least one who operates in what’s supposed to be a free market-centric economy, is not only targeting stock prices but bragging about it is troubling – the greatest Fed Chairman of all time, William McChesney Martin Jr., is not only rolling over in his grave but is about to levitate in Bernanke’s direction to deliver the first apparitional smackdown.

But beyond that, Mr. Bernanke mentioned the Russell 2000 Index’s latest jaunt to imply that the central bank’s actions are helping small business.  Now, he certainly understands that small business is not defined by publicly-traded stocks with a weighted-average market cap of $1.4 billion.  But why did he bring it up?  To get anyone who still believes that everything flowing from his vaunted lips has merit? 

More importantly, he must understand that when higher asset prices are engineered by monetary policy that the reverse move is swift and deep.  Such reality is hardly beneficial to small business, or any business for that matter.   If the Fed Head can’t seem to grasp this as axiomatic then how’s he going to manage the massive interest-rate risk the Fed’s balance sheet has taken on when they reverse course either voluntarily or, more likely, by force? 

And what force, you may ask?  Who knows, it may never happen until the next Fed-induced bubble bursts.  But a couple of possibilities are:  Bond vigilantes citing inflation pressures and pushing long-end yields much higher, a full-blown currency war that brings the FOMC to cease and desist or an FOMC boardroom revolution as the new voting members that revolve into the Committee this year dissent. 

While I certainly don’t believe the economy is about to take off in a self-sustaining manner, this is absolutely the wrong  way to attack these economic issues   More people need to make a stand and yell “Stop!” before the other side of this policy turns terribly ugly, yet again. 

CPI

The consumer price index (CPI) rose 0.5% in December to close the year up just 1.5%.  The core rate, which excludes the food and energy components the rest of us can’t remove, rose just 0.8% for the year.

The large headline 0.5% increase for December was driven almost solely by the gasoline, and commodities component in general.  But overall the inflation numbers are far from levels that will get the Fed interested, as that core rate is half their comfort level of 2.0%.  And with Bernanke’s paranoia over deflation (or his fear of reversing course due to its effect on asset prices, or the unleashing of the interest-rate risk they’ve taken on) he’ll likely attempt to wait until core CPI moves to something closer to 3.0%. 

So what’s the chance of the official inflation gauges running to hot levels?  Well, commodity prices are certainly signaling trouble to come, but the lack of business pricing power is likely to keep CPI down for a while still.  And we really need to see credit expand.  There are very early signs of this occurring, but they’re extremely slight right now – and the high chance of another round of home-price declines may just keep lending down as banks will have to add back to loss provisions as a result.  But if credit does pick up substantially, then inflation will rage – credit expansion remains the key signal to watch. 

Retail Sales

Retail sales rose 0.6% in December (expected to come at 0.8%).  Even though the  number missed expectations, it followed a 0.8% increase in November and the massive 1.6% jump in October to round a strong fourth quarter.  However, there are several key segments to the retail sales data, the most vital being the core figure (excludes gasoline, autos and building materials) because this is the number that funnels into the GDP calculation.  That number came in lighter-than-expected for December at +0.2%, but it’s still up strong for the quarter thanks to November’s particularly big reading. 

The other segment to watch is the ex-auto and gasoline figure, which looked good as it rose 0.5% for the month.  Really most segments posted nice results.  The department store and clothing segments were hit hard, but that’s because of the weather; it was made up in the internet retailing segment, which jumped 2.6%.  The only real weakness remained in the electronics component, off by 0.6% in December and down four of the past five months.  (This may be a signal that some of the boost of late has come from clothing due to the really cold weather; one would think electronics to have participated otherwise.)

We’ll watch to see how retail sales play out after this strong holiday season as spending has outpaced incomes again.  Even with the payroll tax reduction, we may see some of this extra money saved as labor-income generation has been weak. 

Industrial Production

The Federal Reserve reported that industrial production (IP) jumped 0.8% in December (besting the expected 0.5% increase), but the number was padded by seasonal utility use.  (These numbers are seasonally-adjusted but the results were higher-than-normal due to very cold weather.)

Manufacturing production, which accounted for 75% of the overall IP index last month, did rise a nice 0.4%.  (The figure has rebounded by 5.8% over the past year, although that comparison was an easy one as the year-ago level was down 12.5% from the previous cycle’s peak. 

Half of the increase in the index though came from the utility component, which makes up just 11% of the index.  Utility production surged 4.3% in December.  Mining activity, which is the other component of IP, increased 0.4% for the month.

Capacity utilization (CU) rates continue to improve, rising to 76.0% in December for all segment combined, up from 75.4% in November. 

Manufacturing CU rose to 73.2% from 72.9% in November.  But the fact that it remains well below the average of 79% shows that the improvement in factory activity is due more to it coming off of very low levels rather than some historically high level of activity at the present. 

U of M Confidence

The preliminary consumer sentiment reading from the University of Michigan’s gauge unexpectedly fell for January, down two points to a reading of 72.7 – holding above 2010’s low mark of 67.7 hit in October but stuck at a historically weak level.  We’ll get the revision to the January reading at the end of month. 

The overall index was pushed lower by the current conditions measure, which slid five points to a level that just about matches the mid-point of the 1980 & 1981-82 recessions and the lower ranges of the 1990-91 recession. 

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Have a great day!

Brent Vondera, Senior Analyst

Phone: 636-449-4900