U.S. stocks lost some ground yesterday as the broad market was pulled lower by profit taking in the energy sector – the hottest sector of the year.  Declines in the shares of Exxon Mobil and Chevron accounted for more than half of the 41.55 Dow Industrial Average points lost. 

The day’s economic reports were mixed, but weaker-than-expected retail sales data for January and signals of higher pricing pressures were what got the focus as both definitely weighed on the market. 

Specifically on the inflation front, the prices paid gauge within the NY manufacturing report continued to rally and the January import price index came in well-above expectations -- history has shown that data to be a strong leading indicator of CPI. 

We’ll begin to keep a close eye on the official inflation gauges.  Those measures have been very flat for a while now, so we haven’t talked about them much.  But as we’ve discussed, there is inflation in the pipeline and that’s why I’ve focused so much on commodity prices over the past few months.  I still don’t think a harmful bout of inflation can take hold just yet, not is a durable manner, the economy remains much too weak – any substantial interest rate increase from current levels will derail this expansion in quick order; the real inflation problem may be another cycle out.  Regardless, if CPI begins to jump, even in a transitory manner, then traders will begin to question continued Bernanke support and that’s a very big deal for this market

Utilities and consumer discretionary were the only of the 10 major sectors to close higher yesterday.  As mentioned, energy was the day’s worst-performing group.  Basic materials, tech and telecoms also lagged the overall market. 

The CRB Index pulled back yesterday despite higher prices of nickel, cotton, hogs and precious metals. 

Cotton made a new all-time high; nickel remains considerably below its record high – but has rallied 40% since summer.  Silver and gold continued to rebound from their pullbacks in January after the latest reading on UK inflation printed 4.0%.  The energy complex is what weighed on the commodity index as crude, gasoline and heating oil prices fell.  Crude has slid 8.5% since the end of January, closing at its lowest level since November -- $84.40/barrel. 

Market Activity for February 15, 2011

Sector Activity for February 15, 2011

Empire Manufacturing

Manufacturing activity in February showed it’s still got the juice as the first regional report we get for a given month printed acceleration. 

The NY Federal Reserve Bank’s gauge of factory activity within the second Federal Reserve district reported a reading of 15.43 after December’s 11.92. 

New orders, shipments and the number of employees indices all fell but remained at solid-to-strong levels.  Unfilled orders rose, but remained in contraction mode; inventories jumped to the second-highest reading on record, it’s tough to tell whether this jump was desired or not (if desired then it means factories expect orders will remain hot, if not then it spells bad news for production – and remember that durable goods orders have declined over the last three months); and the average workweek rose to a good reading, rebounding from contraction in late 2010.

The prices paid component surged 10 points, while prices received rose just one point.  The overall differential isn’t scary at this point (although in worse shape on other manufacturing regions), but in this weak period of expansion margin compression matters more than during normal times, particularly regarding the effect it has on hiring. 

Import Prices

The import price index rose 1.5% in January (double the 0.8% expected) with the prior month’s reading revised up to 1.2% (previously reported at 1.1%).  These readings follow the 1.6% rise for November and the 1.1% in October. 

This is only the third occasion in the data’s history (I wish it went back to late 1970s when inflation raged, but it only goes back to 1989) in which the measure has posted four consecutive months of 1.0%-plus readings.  The other occasions were during the summer of 2008’s commodity-price spike when oil hit $145/barrel and the summer of 2005 when the price of crude surged 50% in three months (partially of function of Katrina/Rita hitting the Gulf Coast).

On a year-over-year basis, import prices are up 5.3%, the second month of 5.0%-plus.

Retail Sales

January retail sales came in shy of estimates, rising just 0.3% (expected to rise 0.5%) and the December reading was revised down to show a 0.5% increase (previously reported at 0.6%).  Excluding autos, sales rose the same 0.3% (0.5% was also expected).  Here too, the December reading was revised down to 0.3% from a previously reported 0.5%. 

The core reading (excludes autos, gas station receipts and building materials), which gets plugged into GDP, rose a nice 0.4% but the prior two readings (December and November) were revised substantially lower.  These revisions will have an adverse effect on the Q4 GDP.  Whether it actually results in a downward revision depends on whether or not the better inventory data is enough to offset this drag. 

Business Inventories

And on that data, business inventories rose a better-than-expected 0.8% in December (expected to come as 0.7%) following the 0.4% increase in November (revised up from the 0.2% previously reported).  And the sales data that accompanies the report rose a strong 1.1%.  Sales have been very solid over the past three reporting months, mostly fueled by factory sales, but holiday shopping season also delivered good retail sales (even if they were lighter than previously believed). 

Inventories will still have a negative effect on Q4 GDP, as the inventory change in the fourth quarter was smaller than that in the third quarter, but less than a drag that was previously estimated in the initial Q4 GDP estimate and that means it may be enough to offset the lower spending figures.

The solid sales data will certainly help to keep the inventory cycle from grinding to a halt, but those sales may very well show deterioration as we move to mid-year (would have been weaker in the first-half of the year but the payroll tax reduction will delay the slowdown in consumer spending) as the figures will have a hard time matching recent activity. 

NAHB Housing Market Index

The National Association of Home Builders sentiment index remained all but floored in February.  The measure has been stuck at a reading of 16 for four-straight months – the all-time low of 8 was hit in January 2009. 

To put a reading of 16 into perspective, as if the chart below doesn’t do so on its own, a reading of 50 means that respondents are evenly split between those defining market conditions as “good’ and those defining conditions as “poor.”

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Have a great day!

Brent Vondera, Senior Analyst

Phone: 636-449-4900